Recovery Trade in Final Stages for Global Equity Markets?


Global markets showed signs of fatigue in October with the MSCI All Country World Index dropping 1.6%. Emerging markets once again outperformed the developed world although the MSCI EM Index was essentially flat for the month. The S&P 500 had the first down month since February. Volatility increased with the VIX Index closing above 30 on October 30th for the first time since early July. On a number of occasions, investors chose to sell stocks on good news.

Global Equities vs. US Dollar

This year, global equities have demonstrated a strong inverse correlation with the US dollar. The dollar’s relentless slide was interrupted, at least temporarily, in late October. Not surprisingly, this coincided with a correction in the global markets. There is no reason to believe that this link with the dollar will be broken any time soon.

2009 Recovery Trade

The great recovery trade of 2009 appears to be maturing with the path from here largely unknown. Valuations are reasonable but no longer cheap. The economic recovery in the developed world has, so far, proceeded at a very slow pace despite the unprecedented amount of stimulus. Investors are beginning to give more thought to the eventual fiscal tightening and withdrawal of liquidity and what that implies for the world economies and the equity markets.

Banks Raise Rates

The central banks of Australia and Norway have already raised rates. And then, of course, there is a persistent concern about the US consumer deleveraging process, which may undermine US consumer spending for years. The US real disposable income dropped 0.1% in September after falling 0.2% in August supporting the notion that investors’ concerns are generally legitimate.

Liquity is Key

Liquidity should remain abundant at least through 1Q 2010 as the central banks of the US, Europe and China are unlikely to raise rates prior to this. The economic data has been somewhat mixed but the general direction is towards stronger growth next year. The Eurozone manufacturing PMI crossed the critical 50 threshold for the first time since May 2008. The US ISM (Institute of Supply Management) Index posted a stronger than expected improvement to 55.7 in October.

JP Morgan show Growth

JP Morgan’s global PMI also gained in October (Chart 2). The Chinese economy has accelerated as the year progressed with the 3Q09 year over year GDP growth reaching 8.9% compared with 7.9% in 2Q and 6.1% in Q1. Export statistics out of China, Korea, and Taiwan indicate an ongoing recovery in the global trade. Additionally, Germany’s manufacturing orders data has been steadily improving since April.

Earnings look good

Finally, the earnings picture continues to look encouraging with the ratio of positive to negative surprises exceeding 5 to 1 among the S&P 500 companies in 3Q09. The ratio of positive to negative sales surprises improved to about 1.4 to 1 in 3Q from just 1.05 to 1 in 2Q. Previously, investors were seriously worried about earnings being driven solely by cost-cutting without real improvement in the underlying business