Cambridge Weekly Update – 25th November 2019

Markets pause for reality check

Conventional market wisdom holds that the cold and damp of autumn usually heightens the probability of downside volatility in markets – particularly when the economic outlook is unclear. The last quarter of 2018 was a prime example of this. Fortunately, no one seems to have told the markets. The waning of summer only saw the markets’ upward momentum briefly disrupted during October, with stock indices around the world now sitting at highs, not lows, for the year – this is despite an economic and political outlook still plagued with uncertainties.

Central bank liquidity support – a double-edged sword

In recent weeks, we have talked a lot about the puzzle of the current market rally. All around the developed world, stock markets have risen – with many now at or close to their all-time highs. At the same time, economic indicators are, on a charitable interpretation, uninspiring – and on an uncharitable one, perhaps worrying.

This puzzle is clearest when looking at comparisons of recession indicators. If we take the shape of the US yield curve (the difference in yields between government bonds at different maturities – usually thought to be a pretty good recession signal) as our guide, the probability of a recession in the next 12 months has come down substantially. But if we take economic recession indicators as our guide, the probability has risen steadily. Indeed, economic indicators now suggest a higher probability of recession than financial or market-based ones.

US consumers refusing to revert to trend

The Q3 earnings season is now coming to a close, with most companies having reported their results for the period. As we have written before, firms guiding forecasts lower, only to subsequently beat them and get a boost to their stock price, is a well-known pattern – so it is unsurprising that it happened again. Coupled with a return of risk sentiment in capital markets, who seem to be expecting a turnaround in the global economy, this has left the US stock market around its all-time high – despite corporate profits actually having slightly declined over the year.

Read the full Commentary here