We all know that the kind of jumps that we see regularly in the equity market these days are a symptom of its illness (at least, we all should). That is, in a healthy bull market, you don’t get 3%+ daily jumps almost ever. These kind of swings are typical of bear markets where the macroeconomic settings are unfavourable but rays of light emanating from policy action and mini-cycles cause regular gyrations to the upside.
We have one of those rays of light today. In fact, today was as perfect a day for equities that I can remember for years. Let’s go through it.
First, on the big bugbear of Europe, we had global central banks cut the cost of their dollar funding lines. Mohammed El-Erian has a good summary on why at Alphaville:
In justifying the move, the central banks point to the need to counter pressure on “the supply of credit to households and businesses and so help foster economic activity.” This is an objective that will sell well to the public and politicians. But it is not one that will be effectively met by the announced measures. Indeed, the importance of the announcement is elsewhere, involving two related issues.
First, these monetary institutions feel that, again, they have to move because other entities have continued to be too slow and too ineffective; and second, they feel that they cannot, and should not ignore an actual or anticipated need to relieve acute pressures within the banking system.
These two reasons were made even more pressing by last week’s dislocations in the functioning of European financial markets – most notably, the inversion of the Italian yield curve, pressure on government bond markets in core Europe, the growing fragility of the banking system, a drop in market liquidity, and growing hesitation by market participants to warehouse any risk.
The immediate impact on markets unambiguously favors risk assets across the world. The longer-term effect depends on the scale and scope of the follow through from others. This is particularly important as we count down to yet another European Summit on December 9.
Exactly right. It fixes nothing but does push out crisis for a potential fix.
Item two is that the positive data flow in the US continued overnight with ADP employment numbers hugely beating the market, up 206,000 jobs in November. The ADP is a decent guide to the trend in US employment even if its hopeless in terms of magnitudes of change so we can probably expect a less exuberant but decent BLS employment number. In addition to this, we had a good number in the Chicago PMI at 62.3, with new orders jumping to the highest level in seven months. There was also a bounce in pending home sales which we can take with a grain of salt.
None of this is a surprise. As I wrote a few weeks ago, the US is in a nice mini-cycle with inventories caught short ahead of a boost to demand as consumers run down savings. The equity market should have already discounted this data, even if it adds to the positive tone.
Far more significant news, however, was a very positive development at the political level:
Republican leaders said Tuesday they would join Democrats in supporting an extension of the 2011 payroll-tax cut despite some reluctance within the GOP, virtually assuring that American wage-earners will continue to receive the benefit next year.
Republicans still oppose Democrats’ plan to pay for the tax break with a tax on people earning more than $1 million a year. GOP leaders said they would find another way to pay for the tax break and predicted it would pass.
The payroll tax extension is one half of the big fiscal drain scheduled for next year. Removing this overhang shifts half of the 1.5-2% of GDP of scheduled austerity. That gives the US mini-cycle a bit more breathing space to go on.
But the good news did not stop there. As Zarathustra describes today, China also stepped up and delivered a 50 bps cut to bank reserve ratio requirements. This is more and earlier than I expected, given I’ve taken Chinese authorities stated aim to put a lid on the property market seriously. Such generalised cuts will, after all, free up generalised lending. Zarathustra remains skeptical that this is the beginning of a rapid and large easing, and in the context of 21.5% reserve ratios he is right, but it shows a strong intention to not let aims on one sector overwhelm growth in others. Moreover, even if the moves down are slow, which I am beginning to doubt given the pincer China is caught between, falling exports and property, then the intention is now clear and the equity market can draw strength from that for some time.
Nothing has been fixed, of course, most pointedly in Europe, and all of the action actually implies its opposite, dramatically spreading global weakness. But today’s action is the macroeconomic basis for a bear market rally.
