28th July - US Stocks and European Bonds are two bull markets
01 August 2016
TECHNICALS:
WEEKLY S&P chart
This is a powerfully bullish set-up: a completed Double-Headed bull H&S pattern,
Strong support on any pull-back at the Neckline at 2100.
The measured target ?
About 2400.
Only a break beneath the neckline would threaten the bull structure.
WEEKLY Bund Chart
The bull trend remains in place.
Successive Prior Highs are acting as good support: ratcheting the trend higher and higher.
Only a break beneath those Prior Highs (or a failure to get through 166.63 for example) would threaten the trend.
Monthly US treasury 10 year note futures continuation chart
The market has struggled to break out of a sideways drift wince early 2012
WEEKLY DAX Chart
The market has struggled to breakout of the down trend since early 2015. Note though the importance of the level 10350 - a break up through that level would signal a break up through the combined trendline resistances of the long run uptrend (from 2011) and the shorter downtrend from early 2015.
That would be a powerful bull signal.
FUNDAMENTALS:
There is an unusual situation currently in markets: both equities and bonds are in bull markets. Usually bonds are bullish at a time of economic weakness when interest rate cuts are expected and inflation is low. In such circumstances, equity markets are either under downward pressure or in outright bear markets.
And the reverse is obviously usually the case: economic strength drives stocks higher and bonds are correspondingly weak or bearish in anticipation of tighter monetary policy.
What is different this time?
Since the financial crisis/ recession of 2008/09 global growth has been patchy. The Euro zone is yet to mount a convincing recovery and the Japanese economy has been in and out of recession more times than ever before with persistent deflation. The Chinese economy has experienced a period of cooler growth while leading emerging markets such as Brazil and Russia haven’t performed as expected. The UK economy was strong, but now there is the uncertainty caused by “BREXIT” and the US economy is showing promising signs of coming out of a soft patch.
Add in slower-than-usual world trade and weak global inflation and there exists a set of economic conditions that haven’t previously existed in the post WW11 period.
In the US the Federal reserve is eager to normalise interest rates as it judges the US economic recovery is basically sound and will continue to strengthen after the weakness seen in Q1, but with inflation in the US still low and weak globally what is the new norm for monetary policy? Not 5% as previously, we suggest more like 2.5%. And the path to achieving that is likely to be slow and gradual, as the Fed has said on many occasions.
In Germany, the dominant Eurozone economy, the bond market is still bullish. Growth there remains sluggish despite a QE program currently operated by the ECB accompanied by negative interest rates.
Indeed, the Euro zone economy is yet to mount a self-sustaining recovery after having been dogged by the sovereign debt crisis which, in reality, isn’t yet over. There are also question marks still hanging over the health of many Banks in the Euro zone especially in Italy but also in Germany.
In addition, there is the still-struggling Greek economy which is hindered by a severe austerity program condemning it to years of recession. Spain and Portugal have had problems too and the EU has only announced this week that it will not fine those two governments despite persistent failure to get their budget deficits back in line with agreed parameters.
At the same time inflation in the Euro zone is almost zero and unemployment running at very high levels, especially among the young. The contrast then between the US and Euro zone economies could not be more stark.
In the US there is growth, low inflation, rebounding labour market and a Central Bank intent on delivering higher interest rates. In the Euro zone there is a still-struggling economy, low inflation, high unemployment and a Central Bank that has thrown almost every weapon at the problem with at best very, very limited success!
In summary, stocks and bonds are able to rally at the same time due to this exception set of circumstances. Until global growth picks up more uniformly with of some degree of inflation requiring tightening by many more Central Banks (than just the Fed) we cannot see an end to this unusual phenomenon.
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