The Daily Prophet: Wall Street Plays a Game of 'Can You Top This?'

Connecting the dots in global markets.

 Investors sent the S&P 500 Index down for a third straight day, its longest slump since early August. Perhaps they weren't buying what some call sober analysis and others might describe as part of the "silly season." Whatever the case, this is the time when Wall Street strategists give their predictions for the year ahead. What's been startling about this year is the level of animal spirits toward equities even with 2017's big gains and lofty valuations. It seems that no sooner does one firm put out a jaw-dropping forecast then another blows it out of the water.  

Wall Street's new biggest bull is Dennis DeBusschere, Evercore ISI’s head of portfolio strategy. His forecast for the S&P 500 to reach 3,000 next year is now the highest among strategists tracked by Bloomberg, and marks a 14 percent increase from the close of 2629.57 on Tuesday. The analyst's outlook is based on continued earnings growth, which will drive valuations higher, according to Bloomberg News' Lu Wang. Rising earnings is a big theme among all strategists, with the S&P 500's earnings per share seen reaching about $143 next year from about $130 in 2017, data compiled by Bloomberg show. That confidence is reflected in optimism among chief executive officers of large U.S. companies, which is the highest in almost six years, a Business Roundtable survey showed Tuesday.


Even though price-to-earnings ratios at about 22 are historically high, one thing strategists take comfort in is what they see as healthy skepticism toward equities. Bank of America's latest monthly survey of 206 global fund managers overseeing $610 billion of assets found that a record net 48 percent of respondents indicate equities are overvalued. That suggests the demand driving stocks higher is not happening unchecked. "Sentiment is not euphoric," Chris Verrone, the head of technical analysis at Strategas Research Partners, said on Bloomberg TV. "People might be getting more optimistic here, but I don't think they're euphoric yet. It's hard for us to want to bet against the trend as long as that's the case."

COMPLACENCY AND YIELD CURVES
Stock investors may not be euphoric, but it's hard to argue that they're not complacent. The chief investment officer of State Street Global Advisors, Richard Lacaille, is the latest to sound the alarm on the rising number of bets in the market that volatility will continue to dwindle, saying on Bloomberg TV that such wagers are “storing up trouble” for the future. Bloomberg News' Natasha Doff reports that with $2.6 billion in assets, short volatility exchange-traded funds are backed by the most cash on record. Outside of geopolitical risks and perhaps valuations, it's tough to find reasons to be bearish these days -- except if you look at the market for U.S. Treasuries. There, the so-called yield curve continues to shrink on an almost daily basis in what in the past has typically presaged an economic slowdown. The gap between two- and 10-year Treasury yields compressed to 53 basis points on Wednesday, the narrowest in a decade. Some strategists say the bond market is worried that the Federal Reserve, which is due to raise interest rates for a third time this year next week, is being overly cautious and may end up curbing growth too much, especially since there's few signs that inflation is accelerating. "The fundamental story" among bond investors is "one of a central bank committed to the removal of accommodation late in a very long economic expansion," the bond strategists at BMO Capital Markets wrote in a research note Tuesday.


DOLLARS GETTING SCARCE
It may be hard to believe that with all the trillions of dollars created and pumped into the financial system in recent years by the Fed that greenbacks would be hard to come by, but that's exactly what is happening -- at least judging by cross currency basis swaps. The derivatives measure the cost to convert foreign cash flows into dollars. Recently, the currency basis swap curve in euros has become more negative than any time since the end of 2016, suggesting rising demand for dollars from banks and companies in the euro zone. Financial institutions and companies in recent years have taken take extra efforts to fund their operations over the year end in what has become known as the "balance sheet effect." This generally entails the hoarding of dollars, creating a squeeze in demand for greenbacks that can have a negative impact on markets and tighten financial conditions. Ben Emons, the chief economist and head of credit portfolio management at Intellectus Partners, has said this effect may be more pronounced this year as tensions around the U.S. debt ceiling and the competing Republican tax bills in Congress come together in a way that could cause the dollar to appreciate in value.


GREECE'S BONDS HIT A MILESTONE
Remember when everyone thought -- no, was sure -- that Greece's financial troubles would bring down the euro zone, and by extension, the global financial system? Well, judging by the nation's bond market, there's little chance of that happening. In fact, its bonds are having what could only be described as a huge rally. The Bloomberg Barclays Greece Government Bond Index has surged 23.8 percent this year, topping the 6.91 percent for global fixed-income market and the 10.6 percent return for the STOXX Europe 600 index when dividends are included. Greece's bond market hit a milestone on Tuesday, as the yield on the nation's 10-year notes dipped below 5 percent for the first time since 2009, when its debt crisis began. So confident are investors in Greece's future that they agreed to swap 25.5-billion-euros ($30.3 billion) of debt issued during the crisis for new notes due between 2023 and 2042. The Greek government also struck a deal on Saturday with the country’s official creditors for a third bailout review on a technical basis, which was approved by the Eurogroup on Monday. The country still has much to do in order for European lenders to disburse fresh bailout loans, according to Bloomberg News' Sotiris Nikas. The next tranche of money, starting at 5 billion euros, is scheduled to be given out in mid-February if the government implements all the measures agreed to with creditors.



COMMODITIES SINK
The Bloomberg Commodities Index just turned in its worst two-day performance since May, with the gauge dropping 0.83 percent after suffering a 0.85 percent decline on Monday. The benchmark is now at its lowest level since the first half of October. This move lower shouldn't be dismissed. That's because the big drop has been mainly due to weakness in copper and other so-called base metals amid concerns about one very critical source of demand. More specifically, copper was headed to its worst day in more than two years amid the prospect of slower Chinese demand, dollar gains and an uptick in stockpiles, according to Bloomberg News' Luzi Ann Javier. China’s construction of roads, bridges and subways is set for a major slowdown, adding a headwind to economic growth in 2018, a Bloomberg News survey shows. Deliverable inventories from warehouses tracked by the London Metal Exchange rose the most since September, while stockpiles monitored by Shanghai Futures Exchange rose for a fifth week, the longest streak since February. Sometimes referred to as the metal with a Ph.D in economics because of its ability to track the economy’s health, copper is still up 18 percent this year. The rally was spurred by optimism that Chinese growth is improving, mine supply will fall and demand for electric vehicles will rise.


TEA LEAVES
For the first time in months, investors and economists are about to get a better sense of the health of the labor market, one that isn't skewed by layoffs and subsequent hirings in the wake of Hurricanes Harvey and Irma. The flood of data kicks off Wednesday with ADP Research Institute's monthly report on hiring trends, followed by the Challenger job cuts data Thursday and the U.S. government's monthly employment report Friday. The median estimate of economists surveyed by Bloomberg is for the ADP report to show a gain of 190,000 jobs in November, below the average monthly average of 221,500 this year through August. That was just before the index dropped to 110,000 in September and surged to 234,900 in October. To be counted as employed in the ADP tally, an individual needs to be active, but not necessarily paid, as is the case with the payrolls data.

If you’d like to get The Daily Prophet in e-mail form, right in your inbox, please subscribe to this link. Thanks!

DON'T MISS
Untimely Fiscal Stimulus Is a Bond Nightmare: Charles Lieberman

New York Fed Inflation Gauge Bodes Ill for the Bulls: Joe Carson

Housing Market's Comeback Is Poised to Accelerate: Neil Dutta

Our Broken Politics Encourages Deficit Busting: Megan McArdle

Matt Levine's Money Stuff: Agency Costs and Hedge-Fund Size

Bloomberg Prophets Professionals offering actionable insights on markets, the economy and monetary policy. Contributors may have a stake in the areas they write about.

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE