The Daily Prophet: 'Risk On' Just Ain't What It Used to Be

Connecting the dots in global markets.

Everyone likes to talk about how the S&P 500 Index has now gone more than a year without a 5 percent drop from a prior high. But perhaps just as astonishing is that the current "risk-on" cycle for markets has lasted 84 consecutive trading days, the longest stretch since September 2014, according to Bianco Research.

The firm comes to that conclusion by taking a Bank of America index that measures fund flows between equities and sovereign debt using EPFR data and looking for periods when the amount of money moving into equities exceeds that going into sovereign debt. Even with the rise in geo- and political risks and Hurricanes Harvey and Irma, the average investor remains tilted toward equities -- but just barely. The current cycle has produced one of the weakest equity rallies given its length, with the S&P 500 up a modest 3.6 percent versus an average of 8 percent during such periods in the past, according to Bianco. Alternatively, long-end U.S. Treasuries have gained 6.5 percent versus an average of 0 percent.

Although the underwhelming performance of stocks during the long risk-on cycle and the strong performance of bonds may seem counterintuitive, it actually makes sense when you consider the "lethargic" growth in the U.S. economy, Bianco said in a research note. Based on Citigroup indexes measuring such things, U.S. economic data has improved at its slowest pace compared with all risk-on cycles going back to 2003.

Maybe that's just nitpicking. After all, stocks are rising, which is what matters most. In fact, U.S. equities reached a new milestone this week as the ongoing bull market became the third strongest ever, according to Bloomberg News' Lu Wang. At just shy of 2,500, the S&P 500 Index is a hefty 269 percent higher than its March 2009 nadir, surpassing the 266 percent advance notched during the 1949 to 1956 bull market, data compiled by S&P Dow Jones Indices and Bloomberg show. Although that looks impressive, it's less so when measured by annualized returns. This bull market has been the fourth weakest by that measure out of 13 cycles, with a gain of about 17 percent a year. According to Wang, the reason is duration. At 8 1/2 years, the bull market is already the second longest ever, trailing only the 1990-2000 run during the dot-com era. No wonder the latest investor survey by Bank of America Merrill Lynch found the number seeking protection from a big drop in stocks rose by the most in 14 months in September.

The fury of Hurricanes Harvey and Irma is still being felt by the oil industry. U.S. East Coast gasoline inventories dropped to the lowest level in almost three years, according to data from the Energy Information Administration released Wednesday. Flooding from Harvey shut down parts of the Colonial Pipeline, slowing gasoline deliveries from the Gulf Coast up the Eastern Seaboard, according to Bloomberg News' Nico Grant. With Hurricane Irma’s arrival forcing port closures across Florida, some of the state’s fuel stations were left dry. Irma’s true cost on inventories won’t be known for at least another week. U.S. consumer gasoline prices have surged to $2.656 a gallon from $2.347 in mid-August as flooding from Harvey disrupted fuel supplies, according to American Automobile Association data. The rise in gasoline prices is one reason why bond markets are starting to price in faster inflation.

It's not much, but it's a start. Time will tell whether we are witnessing a turnaround for the long-suffering greenback, which is staging its strongest three-day rally since December. The Bloomberg Dollar Spot Index has risen 1.10 percent this week amid speculation that inflation may be accelerating on higher gas prices and talk of U.S. tax cuts, raising the odds ever-so-slightly that the Federal Reserve will raise interest rates before the end of the year. Bank of America Merrill Lynch strategists wrote in a research note Wednesday that based on its analysis of interbank foreign-exchange order flow, not only is there net dollar buying but that such demand exceeds supply by an amount that suggests the dollar's gains may have further to go. This was supposed to be the year of the dollar, as the Fed lifted rates and the Trump administration implemented its pro-growth fiscal policies. Instead, the Bloomberg Dollar Spot Index fell as much as 11.6 percent through the end of last week as inflation slowed and turmoil in Washington stalled Trump's agenda.

Investors in municipal securities are jumping for joy as the Trump administration expresses support for maintaining the tax break on the debt. Treasury Secretary Steven Mnuchin even told the Wall Street Journal last week that the preferential treatment is a subsidy for local governments, not wealthy bondholders. As a result, top-rated state and local government bonds due in five years are yielding just 65 percent of comparable Treasuries, holding near their lowest levels since 2010, according to Bloomberg News' Martin Braun. In their relief, investors may be overlooking a troubling trend. Braun also reports the number of cities reporting an improvement in their financials has dropped to a five-year low as revenue growth slows and they face pressure to spend more on infrastructure. City general-fund revenues are projected to increase by just 0.9 percent this year, compared with 2.6 percent in 2016, as property-tax growth slows and sales and income-tax collections drop, according to a National League of Cities’ annual survey. The share of cities reporting that they’re more able to meet their financial obligations than they were a year ago slipped to 69 percent, the least since 2012.

The Bank of England meeting Thursday will garner the headlines, but don’t discount the potential for big news coming from the Swiss National Bank. With the franc weakening almost 7 percent this year against the euro, markets will focus on whether the central bank backs away from saying the currency is still “significantly overvalued,” according to Bloomberg News' Anooja Debnath. The euro-franc pair traded around 1.1471 on Wednesday, near the 1.1538 touched on Aug. 4 that was the highest level since January 2015, when the SNB discarded its currency floor. While it might be too early for any policy changes, whether or not policy makers address the weaker franc makes it “the most interesting SNB meeting in a while,” according to Nordea Markets’ Andrea Steno Larsen. The central bank is expected to keep interest rates unchanged at minus 0.75 percent, based on all 26 economist surveyed by Bloomberg. 

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