Wednesday , 17 October 2018

Fate Of Stock Market Now In Donald Trump’s Hands – Here’s Why

Bank of America’s proprietary “Global Wave” indicator [see below] just peaked for only the tenth time in 25 years…[with] 5 of the 7 components deteriorating….

The original article by Tyler Durden has been edited here for length (…) and clarity ([ ]) by munKNEE.com to provide a fast & easy read

(Click on image to enlarge)

Commenting on the implications of this inflection point, BofA said that a peak in the Global Wave tends to come with a period of more mediocre returns in equity markets but noted that sustained negative returns are only evident in those episodes that lead to global recession. In the global recessions of 2000 and 2007, the peak in the Global Wave was very close to the peak for the global equity market. Sharply negative returns followed (averaging -14% after six months and -36% after a year) – so what are the consequences for markets? Well, there is good and bad news.

  • The good news is, or rather would be, if the current global wave peak is not like the peaks observed in 2000 and 2007, in other words, if what follows is not a recession.

Here is BofA:

Ex of recessions Global Wave peaks point to a pause not end of equity rallies: Stripping out those two recession periods,

  • the average profile for MSCI ACWI shows a market that moves sideways for 6-12 months around the peak in GW. In 2018, we are so far tracking reasonably closely to that pattern, with global equities trading in a range since the correction from the January highs.
  • The typical profile then suggests a bias to the upside six months subsequent to the peak in the Global Wave.
  • 12 months after the non-recessionary peaks MSCI ACWI was on average 11.6% higher.
  • Indeed, as shown in the chart below, global equities were 10-20% higher 12 months after the peak in Global Wave in 5 of 7 non-recessionary episodes.

(Click on image to enlarge)

  • The “bad news” is that, as the chart below shows,… the average global market return 12 months after the peak was hit was a chilling -36%. A crash of such a magnitude in the current environment – without central bank intervention – would unleash a global recession, if not depression.

(Click on image to enlarge)

The next overlay chart which compares the current pre/post peak inflection point to all the prior ones, suggests that there are two possible outcomes of what happens next:

  1. markets either “shrug it off”, and proceed to rise another 10%, as they did across all historical episodes except 2000 and 2007,
  2. or they crash as they did in those two years.

(Click on image to enlarge)

Here, BofA also notes that some notable parallels exist in the current market backdrop to other, more turbulent prior episodes:

  • Monetary policy is becoming less accommodative as was the case in the early or intermediate-stage Fed tightening cycles in 1995, 1998 and 2005.
  • Volatility, and some instances of financial stress are found in EM, which was also a feature in 1995, 1998 and 2015.

The question, therefore, is what will determine which of two paths the markets take? The answer, according to Bank of America, is simple: “whether we get a trade war or not.”

We see two potential paths for markets.

  1. The first is where there a full-blown trade war which damages global growth and markets have to correct significantly to adjust for lower profits.
  2. The second is where a full-blown trade war is averted (albeit after some initial skirmishes) and markets return to focus on a decent growth and earnings backdrop and equity markets spike sharply higher.

…To summarize:

BofA’s global “late cycle” indicator has just been triggered, and both the economy and markets are now set to stagnate for the next year, or worse, if more adverse developments emerge.

  • The best case scenario is one in which there are no additional stresses on the global economy – in this case, markets will recover and resume rising.
  • The worst-case scenario envisions the trade war between the U.S. and China escalating progressively in a tit-for-tat fashion, ultimately pushing global growth low enough to prompt a recession. In this case, the 2000/2007 scenario becomes the dominant one, and what happens next could be a market crash of roughly 40% in the next 12 months.

Which scenario the markets will follow will depend on how the U.S.-China (and global) trade war develops; in other words, the fate of the stock market is now in Donald Trump’s hands.

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