Market dilemma: Goldilocks or bust?

Weird market moves mean no one knows for sure if Goldilocks is back or if recession is nigh


INVESTORS are riding helter-skelter markets - causing headaches as they try to figure out whether Goldilocks is back or recession is nigh. From stocks, currencies to commodities, a slew of assets are moving in seemingly erratic ways.

Take the US dollar - it's on a rip higher ever since the Federal Reserve took a dovish pivot. Small-cap stocks are among the best-performing equities out there, even though the only thing everyone seems to agree on is that we're late in the cycle. And industrial metals and miners are surging as the world's biggest consumer slows down.

It all helps to explain the lack of consensus that's been on display across markets this year.

"It's very erratic and a clear direction is missing," reckons Georgette Boele, a currency and commodity strategist at ABN Amro Bank NV. "There's a lot of uncertainty with Brexit, trade negotiations, China's economy, the weaker euro zone data and unclear picture about US data - this all makes it a very hard market to trade."

While bulls in credit and emerging markets are on the rampage, government bonds are getting a mammoth bid and outflows are hitting rallying stocks.

Here are some other head-scratchers in markets right now.

Dovish dollar rally

Expectations of looser monetary policy in the world's strongest economy would usually be a headwind for the greenback. Yet after an initial leg lower as the Federal Open Market Committee said it "will be patient" on policy decisions at the end of January, the dollar hasn't looked back.

The Bloomberg Dollar Spot Index rose on Monday for the eighth consecutive session, up about 1.5 per cent since Jan 30.

The key here appears to be taking the Fed pivot in context - American policy makers may be signalling we're near the end of the tightening cycle, but in other key regions the economic and inflationary outlook is even worse. On a relative basis, therefore, the dollar and US assets remain attractive.

Risky and resilient

Despite the headwind of a rising dollar, emerging-market assets have largely held on to the year's stellar gains. The MSCI Emerging Market Index of shares is up 7.2 per cent, while a gauge of developing-nation currencies is also higher.

Despite this, bearish positioning in options markets on these countries' currencies and equities is below the historical average, according to analysts at Morgan Stanley.

Market calculation

Developing-nation assets looked too cheap after a miserable fourth quarter, stimulus in China will fire up the world's second-biggest economy and the dovish Fed suggests there'll be less pressure on global liquidity.

China is the world's biggest consumer of big-name commodities, so a slowdown there might be thought of as negative for miners and metals prices, other things being equal. Looser US policy, particularly on the expectation of slowing growth, should also tend to support gold more than other raw materials.

The yellow metal did indeed enjoy a robust start to 2019, as its status as a counter-cyclical haven came into play. But in a counter-intuitive move, pretty much every industrial raw material seems to have outperformed it.

While iron ore's jump could be down to a deadly dam burst in Brazil, that doesn't explain why nickel - which isn't as dependent on the same facility - should also be on a tear.

As with emerging-market assets, the logic for this may be linked to performance last year: These raw materials had such a miserable run that even as growth worries mount, investors see a lot of upside.

Industrial revolution

This dynamic is echoed in stock markets, where basic resources companies are the best-performing sector in the Stoxx Europe 600 Index. Miners are typically pro-cyclical, making them a risky play this late in the cycle. However, the sector is up 11 per cent since the start of the year, versus 7 per cent for the main European gauge.

A rebound from an overwrought sell-off? Think again. To bulls, it's another clear risk-on signal - and a hint that global growth concerns are overdone.

"The miners are like cowboys, shooting the lights out," said Rene Hochreiter, a mining analyst at Johannesburg Noah Capital Markets Ltd.

"All these fears of a recession last year are disappearing."

Small rebellion

Here's another set of stocks that's not meant to flourish in late cycle: Small caps.

These US companies have risen more than 10 per cent in 2019, outperforming their large-cap counterparts. That's happened even as earnings forecasts for the S&P Small Cap 600 Index were slashed by 3.9 per cent, compared with around 2.5 per cent or so for the S&P 500.

In other words, traders appear willing to take on greater risk for relatively lower returns.

Sure the dollar, easier credit conditions and a still-robust US economy all have something to do with it. But it's another confusing signal for investors grappling with risk-on, risk-off markets. BLOOMBERG

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