Uncategorized, Weekly Update

International Stocks Rebound as a Key Recession Indicator Signals Caution


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Published April 19, 2019

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Stock markets outside the U.S. have joined U.S. stocks in bouncing back strongly since Christmas Eve (see chart below). However, as the following commentary from Schwab discusses, there are reasons for concern about this rally.

Stock markets outside the U.S. have joined U.S. stocks in bouncing back strongly since Christmas Eve

The composite leading indicator for the world economy from the OECD (Organization for Economic Co-operation and Development) is approaching a potentially significant threshold, as can be seen in the chart below. Over the past 50 years, a drop to 99 seems to happen right around the start of global recessions: in early 2008, early 2001, late 1990, late 1981, mid 1974, and mid 1970. The indicator has never crossed 99 and not been accompanied a recession. It’s now at 99.1.

Leading indicator for the world economy

Leading indicator for the world economy

A rebound in this indicator from the current level, as we last saw in 1998, would be welcome news. Despite this week’s downward revision to 2019 global economic growth estimates by the IMF (International Monetary Fund), there have been some signs of stabilization in global economic data. However, there are developments in the near future that could prompt further weakness, like revived trade tensions between the U.S. and Europe, mentioned above, or an abrupt and disorderly Brexit.

Avengers: Endgame is predicted to smash box office records upon its release later this month, but just as widely-watched is the drama over the Brexit endgame. This week, the U.K. was granted a widely-expected second exit date extension to October 31, with the option to leave earlier. We see three main scenarios the path of Brexit may take over the coming months, each with differing market outcomes.

Brexit: three main scenarios

Hard Brexit: One way an abrupt and disorderly U.K. exit from the European Union could still happen is if Parliament is unable to agree to a deal by October 31. A further extension seems unlikely given likely opposition by French President Macron, it only takes one of the other 27 EU member nations to veto an extension. This unanticipated outcome could reverse the gains in U.K. stocks and the British pound seen this year.

Soft Brexit: Prime Minister May could succeed in passing a modified version of her EU-approved withdrawal agreement through Parliament by relying on support from the Labour party. A deal could still be ratified by the U.K. Parliament by May 22, in time for the U.K. to leave the EU at the end of June and avoid participating in European Parliament elections, but seems unlikely given divisions within the U.K. Parliament. While a version of this scenario seems to be anticipated by markets this year, U.K. stocks and the pound may post modest additional gains with further confirmation toward an eventual “soft” Brexit.

No Brexit: In exchange for the Labour party’s support for a modified version of her Brexit deal, Prime Minister May might have to agree to a second referendum where British voters would be given a final chance to choose between May’s version of Brexit or no Brexit at all. Alternatively, a power struggle among conservatives to replace May could delay progress on an agreement by October 31, prompting the U.K. to revoke Article 50 to stop the clock on Brexit.
U.K. stocks and the pound could rally further on a heightened probability of no Brexit at all.

It is difficult to place probabilities on these three political outcomes, but the stock market seems to be expecting that a hard Brexit will be avoided since U.K. stocks are up a little over 10% (according to the FTSE 100) so far this year. If this worst-case scenario can be avoided, along with the negative economic consequences it is expected to bring, it may also be good news for the global economy as the global leading indicator nears an important threshold.


Market Update

Investors looked this week to the first batch of earnings to see if they could keep this year’s rally moving forward. Monday brought a tight trading day with stocks flat as earnings from Citigroup (C) and Goldman Sachs (GS) failed to spur enthusiasm. Stocks closed flat again Tuesday though the Nasdaq eked out a slim gain as semiconductor shares shined. News that Apple (AAPL) and Qualcomm (QCOM) resolved their long-standing dispute brought buyers into the semi sector. Healthcare stocks continued to struggle as ideas floated by the White House to rein in drug prices and discussions in Congress to pursue a sort of “Medicare-for-all” approach have brought uncertainty and overshadowed strong financial results in the sector. A flood of earnings Wednesday resulted in a standoff with slight downside for the S&P 500. Follow-through buying in the tech sector and strong results in the transports failed to spark buying, however, as investors generally were in a profit-taking mood. The small-cap Russell 2000 slumped -1% while the healthcare sector slid -3%. Upbeat results in the industrial sector and a solid retail report pushed stocks slightly positive Thursday though buying was once again scarce as the S&P 500 wrestles with resistance at 2900. Markets were closed Friday.

Investors seemed to somewhat “sell the news” this week as earnings came in generally strong but failed to ignite any fresh buying interest. The S&P 500 (SPY) closed the week unchanged at -0.05%. The Nasdaq 100 (QQQ) rose +0.84% on the strength in semiconductors while small-caps (IWM) fell -1.29%.

Warm wishes and until next week.