The Daily Prophet: Normal Makes a Comeback in the Stock Market

Connecting the dots in global markets.

Ever since the U.S. presidential election in November 2016, it seems, many investors and pundits have questioned the rally in equities and the rising values placed on share prices. Their main argument was that stocks shouldn't be so richly valued given the suddenly not so predictable nature of U.S. politics. Well, the recent turmoil in stocks should sideline the discussion.

That's because the 10.1 percent drop in the Standard & Poor's 500 Index from its closing high on Jan. 26 through Feb. 8 left the gauge trading at 16.5 times forecasted earnings, a level last recorded in early November 2016 and down from 18.5 times, according to the strategists at Bloomberg Intelligence. Perhaps, then, it was a bit of bargain hunting that pushed up the S&P 500 on Monday by as much as 1.87 percent, the most since Nov. 7, 2016, and drove the Dow Jones Industrial Average higher by more than 400 points. Members of the S&P 500 are posting revenue and earnings for the fourth quarter that are exceeding estimates, with profit growth of 16 percent topping forecasts of 12.7 percent. As a result, analysts are boosting their outlooks for the year, expecting earnings to expand at "a very robust" pace of 18 percent, according to the BI strategists.

Although stocks may be a bargain based on recent history, the drop in valuations has yet to bring price-to-earnings multiples in line with the average ratio of 15.5 that marked the bottom of the last two corrections, according to Bloomberg News' Lu Wang. To get there, the S&P 500 would have to fall to 2,417, or about 9 percent below Monday's closing level of 2,656 in New York. “The base case here is that the fundamentals are just as good as they were in January, before the volatility started,” Michael Purves, the chief global strategist at Weeden & Co., told Bloomberg News. “But the surface is going to be choppier.”

One obscure -- but critical -- corner of the money markets is getting a lot of attention lately, and it seems to have a lot to do with the pending deluge of short-term borrowing by the U.S. government as the budget deficit swells. A gauge of where markets see bank borrowing costs in coming months, known as the FRA/OIS spread, is the widest since last February. The thinking is that more government supply will draw money that is sitting in other money-market instruments, raising borrowing costs for all. It's notable that the government's auction of $42 billion in six-month bills Monday drew $2.74 of offers for every $1 offered, marking the weakest demand for that maturity at a government sale since 2009. The increase in the FRA/OIS spread has been gaining momentum in the wake of Congress’s suspension of the debt-ceiling. Overall, the government is forecast to at least double its debt sales this year to more than $1 trillion -- the most since 2010 -- to make up for the lost revenue from the tax cuts.

Currency traders are not ready to signal the all-clear from the recent turmoil in riskier assets. While stocks and junk bonds staged a big rebound Monday, the Bloomberg Correlated-Weighted Index for the yen versus nine other major currencies held at about its highest levels since mid-December. The yen is seen as haven in times of crisis largely because its large current-account surplus means it doesn't need to rely on foreign money to finance its operations, unlike the U.S. Gains in the yen also reflect an improving economy. Last month the International Monetary Fund boosted its forecast for how much the nation's gross domestic product will expand this year by 0.5 percentage point, the most of any major economy except for Germany. There are some heavy negative forces weighing on the yen, too. News outlets in Japan are reporting that Prime Minister Shinzo Abe plans to nominate Haruhiko Kuroda for another term as chief of the Bank of Japan. The selection of Kuroda, 73, would indicate that Abe wants to continue the monetary stimulus program that has weakened the currency, according to Bloomberg News' Brett Miller.

China’s banks dished out a record amount of new loans in January as curbs on shadow lending swelled balance sheets amid a traditional new-year credit surge. New yuan loans stood at 2.9 trillion yuan ($460 billion), versus a projected 2.05 trillion yuan -- the most since records began in 1992, according to Bloomberg News. The robust credit demand illustrates the challenges faced by China’s leaders as they attempt to slow over-borrowing in the credit-hungry economy, which last year outstripped forecasts to post its first annual acceleration since 2010. Still, seasonal factors exaggerate the trend at the start of the year, and an ongoing clampdown on funding outside traditional bank loans may have diverted some business back to mainstream lenders. "So far, China’s steps toward deleveraging have come without any price in lower growth,” said Bloomberg Economics chief Asia economist Tom Orlik. "Markets though, are already on edge, with a bond sell-off in October and November and an equity plunge in February."

With Valentine's Day on Wednesday, chocolate consumption is on the rise. In the five years ending 2022, U.S. retail sales of confectionery chocolate will climb 2.2 percent to 1.4 million metric tons, fetching $20.3 billion, according to researcher Euromonitor International. Rising demand is helping to reduce a global glut of cocoa, chocolate's main ingredient, while pushing up prices, Bloomberg News' Marvin G. Perez reports. Cocoa futures in New York have climbed almost 9 percent in 2018, making them one of the year’s best-performing commodities. Hedge funds have switched to betting on an extended rally, after holding negative wagers for the past two months. The gains mark a reversal from the last two years, when futures plunged more than 40 percent amid a global glut. The lower prices took a toll on growers, who cut spending on farm maintenance. Yields are dropping in Ecuador, South America’s largest producer. Indonesia, which used to be the world’s third-largest grower, is expected to become a net-importer this year as production declines and demand climbs, Perez reports. Recent dryness is also threatening output in parts of West Africa, which accounts more than two-thirds of global supplies.

Large U.S. companies such as Walmart and AT&T have stolen the headlines following passage of tax reform, announcing surprise bonuses for workers that they credited to lower tax rates. On Tuesday, we'll find out how small businesses feel when the National Federation of Independent Business releases its monthly sentiment index, which has surged to the highest levels since Donald Trump's election victory in November 2016. The best outcome is for a reading of about 105 or better for January, versus 104.9 for December, with the part of the survey measuring selling prices just below a reading of 10, according to Steven Englander, the head of research and strategy at Rafiki Capital. That would translate into stable inflationary pressures and confidence in growth, Englander wrote in a research note.

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