The global economy is doing well, volatility has receded, and the rise in US bond yields has slowed. Simultaneously, even short-term US real rates have turned positive at a time of some extraordinary geopolitical events. For the first time in a decade, investors are being rewarded for sitting on the fence. This weighs on the momentum of the stock market rebound.
There is no lack of extraordinary international political events lately: April began with an escalating exchange of import tariff threats between the US and China. The tensions have eased with the start of official negotiations, but the dispute could flare up again at any point as numerous trade-related decisions and events are approaching. At the same time, the two Korean states’ leaders held a historic summit, vowing to work toward denuclearization and to formally end the Korean War. Furthermore, a summit between US President Donald Trump and North Korean leader Kim Jong-un will be held on June 12. After years of intense saber rattling, a significant détente has occurred on the Korean peninsula, which is clearly a positive. The process until actual agreements are signed, however, may prove long and difficult.
Then, on May 8, the US opened a (not entirely) new geopolitical front by announcing its withdrawal from a 2015 agreement to curb Iran’s nuclear program, announcing that it would reinstate financial sanctions against the Islamic republic. This event, albeit expected to some degree, may further contribute to a higher level of oil prices, which could in turn make it more difficult for central banks to ease monetary policy if growth were to slow markedly in the future - increasing the risk of a stagflationary outcome.
On the other hand, a case can be made that these developments could end up producing mostly positive results in the end, such as new, workable agreements on trade and a lasting peace in Korea. Indeed, market volatility has receded somewhat over the past month.
Nevertheless, upward momentum in the stock markets has faded in tandem as well. The latter is remarkable, given that most of the economic data continue to point toward only a modest and temporary slowdown of global economic growth (if any), with only marginally higher (energy price-driven) inflation rates. The US corporate earnings season for the first quarter, meanwhile, was among the strongest on record in terms of the number of companies beating (even the significantly increased level of) expectations.
Despite the good fundamentals, the stock markets have generally failed to regain any meaningful upward momentum. While recent laggards such as Europe and Japan finally rebounded after several months on the back foot, the broader global indices for both developed and emerging markets continue to trade little changed year-to-date. In short, investors seem unsure what to make of all this unusual mix of events, preferring to stand on the sidelines for now.
Economically, there is a sense in the markets that the growth cycle may have peaked, while the extraordinary geopolitical developments either seem to be too good to be true, or are liable to lead to difficulties further down the road.
Note: The next edition of the LGT Beacon is scheduled for mid June 2018.