Ok, here we are ahead of another weekend of place your chips black or red. Looking at market levels in Europe, there is a big assumption that Macron makes it into the 2nd round notwithstanding the tight polls. The CAC is all of 1.5% from its highest level of the year (although still down more from its 2015 peak), the euro trades well above $1.07 and the French 10 yr yield sits at just .90% with its spread to the German 10 yr at the most narrow in two weeks. So, stating the obvious, if Macron is in the top two, stocks rally, euro rises and bond yields jump. We’ll also see a stock rally elsewhere and bonds will selloff with yields higher. What we will also get is Mario Draghi resting a bit easier which likely means we’ll get another taper by the end of the summer. The Fed will keep raising rates as long as they continue to look at the backward looking labor and inflation stats and maybe we see QT. Now that the BoE has ended QE balance sheet enlargement, maybe we get a rate hike some time after the UK election in June as Brexit negotiation fears wane. A tailwind here, a headwind there. As for the BoJ, Governor Kuroda is truly out of his mind in a mad scientist way. In case you missed his comments yesterday in an interview on Bloomberg, in response to a question about reaching monetary limits he said they own 40% of JGB’s which means there is 60% left and he doesn’t “see any constraints to BoJ policy.”
This all gets to the changed focus of markets that was highlighted post US election. Stocks now like higher yields because it validates its view of quicker economic growth. Historically that has been the right move initially. And I emphasize initially. Memories are short however this time around because what benefited stocks so much in this bull market were low rates and QE, modest growth, profit margin gains and multiple expansion. We now have at least rising short rates and less QE and maybe QT, hopes for tax reform induced faster growth, profit margin declines because labor is getting more and we’ll soon see on multiples but they are most likely to decline as the Fed keeps hiking. Interesting times.
On the rally in stocks yesterday on the healthcare overhaul and tax reform hopes, do we need another reminder that this is the crux of the bull case right now? I want this reform as much as anybody but it just reinforces my belief that the post election rally has been solely driven by these hopes. On the possibility that we do get tax changes this year, I believe we do as I think the urgency is there to do so. I just think monetary headwinds will eventually overwhelm the fiscal optimism with respect to market direction by year end but my readers know my thoughts on that already.
We saw another month of disappointing UK retail sales and this is now a recurring theme unfortunately as inflation rises and wages don’t keep up. Retail sales ex auto fuel in March was lower by 1.5% m/o/m, below the estimate of down .5%. The y/o/y gain of 2.6% is the 2nd slowest since December 2015. These figures are a measure of volume, not price so has greater relevance in gauging the impact of price. Sales ex auto fuel on value/price was down by 1% m/o/m and up 4.7% y/o/y. Looking at volume sales ex auto fuel for the all of Q1 saw sales down 1.2% q/o/q which is the 2nd biggest decline since 2010. The national statistics office said the softness in sales “seems to be a consequence of price increases across a whole range of sectors.” After a great week, the pound is down a touch in response and gilt yields are dropping.
Also out of Europe was the manufacturing and services composite index for April which was up by .3 pts to 56.7, the best in 6 years. Germany’s index actually fell m/o/m but was offset by a gain in France. Employment in particular “rose to the highest for almost a decade as firms boosted operating capacity in line with buoyant demand and widespread optimism about future prospects. Price pressure meanwhile remained among the strongest seen over the past 6 years.” Also on the rising inflation, “supply chains also continued to tighten, signaling a growing trend towards a sellers’ market for many items…Evidence of rising wage pressures also continued to be seen.” Mario might finally get what he wants and if Macron wins, we can all hope for even quicker European growth if their bond markets don’t revolt. No free lunches here.