The Daily Prophet: 'Quite High' Doesn't Mean Irrational Exuberance

Connecting the dots in global markets.

Stocks were flying today until the Federal Reserve crashed the party. Once again, the central bank decided to remind everyone of something they already know. In the minutes of their last meeting on March 15, officials said equities are "quite high relative to standard valuation measures.” It didn't help matters that House Speaker Paul Ryan was reported as indicating that tax reform faced a higher hurdle in Congress than health care reform.

Yes, valuations are relatively high, but they have been for the last few years and that hasn't stopped the bull market. Nevertheless, the S&P 500 fell 0.31 percent, the most since March 21, after rising as much as 0.77 percent. The Dow Jones Industrial Average went from being up as much as 198.26 points to falling 41.09 points. The declines may also have something to do with traders not wanting to risk being long going into President Donald Trump's meeting with China President Ji Xinping on Thursday and the jobs report on Friday. Also, this is the not the first time the Fed has raised concerns about stock prices and traders know that if the market really started to head south, this central bank would, like it has done so often in recent years, put off any further interest-rate increases.

It's not as if the stock market is built on smoke and mirrors. Corporate profits have started to rise again, and the dollar has come off its highs, which should benefit the sales of the big, multinational companies. Globally, earnings upgrades in March outnumbered downgrades for the first time in six years, according to Bank of America Merrill Lynch. That has usually preceded an equity rally in the following 12 months, according to the firm.

The other big news to come out of the Fed minutes was that most central bank officials backed a policy change that would begin shrinking the central bank’s $4.5 trillion balance sheet later this year, most likely but not reinvesting the proceeds of maturing bonds into new ones. So, bad news for the bond market, right? Apparently not. Treasuries actually erased their losses and posted small gains. Later this year is a lifetime away in the bond market, and traders are familiar with the tendency of the Fed to be overly hawkish. Two bond-market titans that correctly picked last year’s uptick in inflation are now signaling consumer prices have peaked for now., according to Bloomberg News' Adam Haigh and Wes Goodman.  Pacific Investment Management Co. is scaling back its outlook for inflation, saying an increase in job-market participation will dent wage growth and oil’s pullback will also be a damper. For DoubleLine Capital LP’s Jeffrey Gundlach, inflation this year has passed its peak, meaning the reflation trade that’s dominated markets in 2017 could peter out.

Those bullish on the greenback were disappointed, with the Bloomberg Dollar Spot Index erasing its gains and falling for the first time since Friday. That's because nothing the Fed said caused the futures market to price in anything more than one more rate increase this year. The drop in Treasury yields also weighed on the dollar, which has broadly fallen year-to-date. And if the Republicans really can't get anywhere on tax reform, that may weigh on the economy and cause traders to start pricing our Fed rate increases.


The weakness in the dollar weighed on commodities, which are largely traded in the U.S. currency. Still, that didn't overshadow the fact that at one point the Bloomberg Commodities Index reached its highest level in a month, buoyed by base metals after a plan was announced to develop an economic zone near Beijing. One notable commodity is raw sugar. Futures jumped the most in three months after India moved to allow some imports. The world’s second-largest producer and top consumer will authorize inbound shipments of 500,000 metric tons of duty-free raw sugar, according to government officials.

China's equities are heading into the summit meeting between Trump and Xi on a high note. The Shanghai Composite Index climbed 1.5 percent on Wednesday in its biggest gain in more than seven months. The rally was led by materials and industrial companies on optimism that plans for a new economic zone near Beijing will boost earnings, according to Bloomberg News' Jeanny Y. China announced Saturday that it would develop an economic zone called Xiongan outside Beijing, prompting hordes of prospective buyers to throng to the region. The Shanghai benchmark has advanced 5.4 percent this year, while Chinese shares listed in Hong Kong have rallied 10 percent.

Oh, to be a fly on the wall at Mar-a-Lago tomorrow, the Florida estate where Trump will host Xi. In a bit of a role reversal, it might be the Chinese leader who that lectures the Americans against abandoning free trade principles, according to strategists at Brown Brothers Harriman. Beyond that, markets don't expect any bold news that could affect asset prices other than a decision to hold trade talks, like one ones the U.S. and Japan agreed to after Prime Minister Shinzo Abe's recent visit. As Ken Peng, an investment strategist at Citigroup in Hong Kong put it, ``It's more a bargaining game rather than one where punishments are doled out." The Census Bureau figures this week showed America’s merchandise imports from China declined by $8.6 billion in February on an unadjusted basis, the biggest drop on record. The U.S. goods trade deficit with China narrowed to $23 billion. A big win for Trump would be at least a nod from Xi that he's willing to open its markets a bit further.

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Fed Knows Better Than to Be Fooled by 'Soft' Data: Tim Duy

Qatar's Bold Move to Reassert Grip on LNG Markets: Robin Mills

Don't Mourn the Death of Stock-Picking Just Yet: Barry Ritholtz

Small European Currencies Are Just a Headache: Leonid Bershidsky

How This Week Will Affect U.S. Reflation: Mohamed A. El-Erian

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