One of the notable features of improving sentiment in global stock markets over the last 6 months has been its reliance on 'soft' economic data and a continuation of positive surprises. We cautioned in March that economic surprise indices were both seasonal and mean reverting and also highlighted the tightening of monetary conditions in China, historically linked to declines in iron ore prices.
Six weeks later, global economic surprise has rolled over outside Europe while energy, coking coal and iron ore prices are falling sharply.
Exhibit 1: Economic surprise indices rolling over in Q2
Exhibit 2: Reflation trade? Commodity prices declining
Our earlier fears have therefore been borne out by the events of recent weeks, leading to a 15% underperformance of the global basic industry sector since the peak in late February, Exhibit 3. From a strategic perspective, it also appears too early to jump back in; the sector remains well above the relative lows recorded in early 2016.
Notably, while the US and China may have eased off, continental Europe has uncharacteristically continued to deliver on the early promise of a cyclical upturn. This improvement in sentiment, occurring at the same time as some of the Trump optimism, gives way to a more realistic view of any US fiscal stimulus, and has been much more supportive of the euro than we expected at the start of the year.
Exhibit 3: Basic industries have underperformed by 15% since Q1 peak
However, while we were prepared to overweight commodities and energy last year on the basis of real distress in terms of valuations, it is in our view much too early to be thinking along the same lines now. And for global equity markets in general, the easing of growth in the US and China, with the most recent FOMC statement clearly indicating a bias to tighten in June, is likely to keep major indices trading close to current levels at best in the short-term.