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What Next?

Fri, Feb 9, 2018 - 9:34am


Originally published at The Boock Report

I want to highlight again my belief that this market selloff is all about rising interest rates and a slowing flow of liquidity from the Fed, ECB, and BoJ. Yes, the global economy is good and earnings have been solid but for at least right now, this is a P/E multiple reassessments as the positive fundamentals have been FULLY priced in and then some. To highlight, assuming US earnings for 2018 will be about $155 per share, that would be a 60% gain since the end of Q4 2012. At the S&P 500 high in late January, this index was up 100% since the last day of trading in 2012. Thus, P/E multiple expansion was a big boost to this bull market over the past 5+ years. If the stock market just rose with the earnings gain during this time, the S&P 500 today would be at 2280.

See Prepping for a Bond Bear

If this market selloff becomes something more, it will eventually impact the economy and that will be a new part of the discussion but I'm not going there just yet. I hear all the time, a bear market can't happen until we get a recession which for most of the history of the US stock market that was true. But, the last two recessions were caused by falling asset prices and the next one we get, whenever that might happen, will be driven by rising interest rates, a fall in stocks and a subsequent drop in consumer spending and investment.

Inflation in China moderated y/o/y as expected in January. PPI rose by 4.3% vs 4.9% in December while CPI was up by 1.5% vs 1.8% last month. Of note within CPI was that inflation ex-food and energy slowed to 1.9%, the lowest since February 2017. For PPI, the comparison's get tougher as January 2017 saw a 6.9% gain. Bottom line, Chinese data in January and February are always distorted by the timing of the Lunar holiday so I'm not going to make much of these figures. I do want to say though, low inflation is what we should want as inflation is a tax at the end of the day. Chinese bond yields are little changed in response while the yuan is bouncing back after yesterday's sharp selloff. Chinese stocks though continue to remain under pressure especially property stocks where the Shanghai property stock index plunged by 16% this week.

Following on the theme of the impressive turnaround in the French economy on the heels of Macron's Presidency, December industrial production rose .5% m/o/m, above the estimate of up .1% and was led by an upside surprise in manufacturing. Manufacturing production was up 4.7% y/o/y. Because the data release is always somewhat dated it is never market moving but the economic situation in France has clearly improved. The euro is little changed and European sovereign bonds are mixed after yesterday's sharp selloff and late day rebound.

Even Italy is seeing some economic bright lights as its industrial production figure in December rose 1.6% m/o/m, double the estimate. The next big event for Italy is the upcoming election on March 4th. Italian politics are always a mess as I believe they've had about 70 different governments since WWII but the possibility of a win by the Five Star Movement would be a problem for the economic momentum that has developed.

UK industrial production in December missed expectations due to a sharp drop in oil production but the manufacturing component was about in line. A day after touching $1.40 on the hawkish rate hold by the BoE, it's backing off to around $1.38. The 2 yr gilt yield touched .73% yesterday morning and has backed off to .67%.

For daily macroeconomic analysis and asset class positioning, visit boockreport.com

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