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Bull market's anchor at risk in shifting growth story
TRADE skirmishes are focusing minds on a simmering threat to markets: the eventual easing of synchronised global growth.
Such a scenario would raise the spectre of a more-complex trading environment that would catch investors off guard as asset correlations increase, as well as a more subdued appetite for risk taking, according to a growing chorus on Wall Street.
The trade tensions have arrived at a risky time, with the Morgan Stanley developed market cycle indicator nearing levels last seen just before prior recessions. The US version - which includes economic, credit and corporate indicators - is close to its 2007 peak. In Japan, the measure has already begun to fall from the nearly three-decade high notched last year.
"The synchronised global economic expansion is rolling on," Richard Turnill, global chief investment strategist at BlackRock Inc, wrote in a note this week. "But we see a wider array of potential outcomes ahead as the cycle matures."
While a coordinated upswing remains the base case - a boon for global stocks - one-direction markets are no longer a sure thing, he said.
A protectionist US trade stance threatens the industrial cycle and the weak-dollar trajectory that has supported the emerging-market boom. At the same time, fiscal stimulus raises US overheating risks that would spur volatility across asset classes, BlackRock warns.
"Call it de-synchronisation through a tariff war that's causing financial conditions to tighten and market volatility to stay elevated," said Ben Emons, chief economist at Intellectus Partners LLC. "This could revisit the 2015-2016 period when global economic uncertainty spilled over into markets that are highly-levered."
Equity traders appear to have gotten the memo. The Cboe Volatility Index has repeatedly climbed above 20 in recent sessions, a level it never reached in 2017. That may be a sign of the dawn of a new order, rather than merely lingering tremors from February or the recent tech rout.
The VIX curve, whose contracts track the implied volatility of the S&P 500 index over time, shows prices for futures expiring in the near-term remain subdued compared to the extreme uptick in February. That's a sign that the recent equity decline "was not 'emotional', but an adjustment to a higher structural volatility backdrop," according to a note from Dennis Debusschere, the head of portfolio strategy at Evercore ISI.
Countries converging to the same economic beat helped to place a ceiling on market volatility last year, spurring a melt-up in global stocks along the way. With still-muted dispersion in economic data across developed markets relative to the historic norm while businesses and consumers remain confident, there's ammo for bulls yet. But a downtrend beckons, say strategists at Sanford C Bernstein & Co. "We expect the world to become less synchronised over the next year and at the same time the level of growth to fall," a team led by Inigo Fraser-Jenkins wrote in a recent note.
As anxiety builds over a less-even economic environment, assets become less tethered to their underlying fundamentals, according to Bernstein. Instead, macro forces can override factors like corporate cash flow, causing correlations to rise. And without the backstop of a deeply synchronised economy, changes in the discount rate also impact assets to a greater extent.
Correlation between assets has started to rise after trending far below the norm last year amid steady global growth. Cross-asset correlation registered the fourth-largest jump on record during the markets-wide sell-off in February, according to data compiled by Credit Suisse Group AG. In-tandem swings now operate just above their historical average, judging by the bank's cross-market contagion index.
Another challenge awaits markets in the shape of shifting monetary trajectories that may finally bring dollar bulls a lucky break. Morgan Stanley strategists project a stronger greenback "once investors start to anticipate that global growth may become less synchronised with the trade tensions, pointing to growth divergence with the US outperforming".
And regardless of any fallout from the protectionist rhetoric, the world's biggest economies look set to diverge. In the US, the tight labour market may finally spur a spirited uptick in price pressures while in the euro area inflation remains subdued, according to Nordea AB analyst Martin Enlund. And European expansion is already showing signs of having peaked. Growth in manufacturing cooled to an eight-month low last month, while orders in the region's largest economy underscore diminished industrial momentum.
"The 'political risk' narrative will re-emerge as the 'global synchronised economic recovery' narrative fades," Vincent Deluard, a global macro strategist at INTL FCStone Financial Inc, wrote in a note. BLOOMBERG