How the stock market can remain indifferent to economic data remains a mystery

Outlook:

Yesterday's data casts a pall over everything that equities are bravely pretending not to notice. Initial unemployment claims were 885,000 in the most recent week, up from 962,000 the week before and contrary to the forecast of a drop to 800,000. It's the highest number of claims since early September. TradingEconomics notes "about 455 thousand people applied for help from the Pandemic Unemployment Assistance scheme, which covers workers that do not qualify for initial claims, compared with 415 thousand in the previous period."

You don't have to be a bleeding heart liberal to see that numbers like this point toward lousy economic outcomes and soon. Then there is the federal moratorium on evictions coming to an end on Dec 31, allowing landlords to force millions out of their homes to heaven-knows-where. The number of homeless persons flooding shelters and living in cars is appalling, and may end up being the symbol of the Trump administration, along with collapsing border walls.

How the stock market can remain unattached or perhaps indifferent to economic data remains a mystery. The usual metrics like purchasing managers indices and consumer spending must have a chilling effect at some point. But analysts galore have been saying this since February and after the March crash, have been wrong for many months. The question becomes whether equities will ever reflect economic reality, and strangely, the answer may lie in who wins the Georgia run-off election. If the Republicans win, they retain control of the Senate and can obstruct to their heart's content. The US economy doesn't get recovery money, including infrastructure spending. Because traders and investors act on expectations, Republican obstruction means a delay in the recovery that then has only vaccines on its side. Instead of a summer return to some kind of normal, it can be year-end 2021.

If the Dems take the Senate, it's a whole other kettle of fish. Taxes will go up, delivering an equity wobble, but recovery can roar. So can inflation expectations, leading to an improvement in yields, whatever Mr. Powell may say about inflation taking a very long time to return.

In the first scenario, risk-off can sneak and slither back into the big picture. The main beneficiaries of recovery, the emerging markets, can get the jitters, and not only to the extent they are dependent on the developed countries buying their goods. EM's are far behind in the vaccine race and will have their own internal problems. Hence our recent forecast of recovery growth becoming correlated with pandemic recovery.

In the alternate scenario in which the Dems take the Senate, we get the stimulus but at the same time, the Republicans will raise a stink about the deficit and promote stories about inflation, loss of preference in investment flows, etc. We would then have a different kind of market that ignores economic reality, in this instance ignoring better growth prospects to focus instead on the danger of overspending.

In both cases, the shadow of risk aversion raises its head. In Case One, risk off comes from the US failing to get recovery at the optimum pace and instead flailing. In Case Two, risk off comes from inflated fear of deficits and other drawbacks of the Dem agenda.

Bottom line, we are about to enter a three-week period ending on Jan 5, when Georgia votes, that may be characterized by rising anxiety and uncertainty. That doesn't necessarily mean rising currency volatility, but it does mean we can't count on a steady trajectory of ongoing dollar weakness. Besides, Trump is busily manufacturing crises to appear in his last 33 days.

Then there is the whole year-end thing. We normally expect the Big Players to pare positions ahead of a new year, to protect their bonuses, on headquarters orders to square up, and common-sense caution. Positioning can have just as big an effect as real data. And the holiday and year-end comes just as several currencies are at multi-year highs against the dollar, including the pound, euro and yen. A little retreat seems sensible.

We intend to sit most of it out. Christmas Day is a week from now and we will stop writing and trading on Wednesday, Dec 23. We will take the entire following week off, too, and so should you. Then we can start fresh in January when the vaccine saga will be clearer, along with a few other things. Probably the most important data point will be whether the US bends the curve over the next two weeks.

Important Tidbit: The Merrill Lynch BoA monthly fund manager survey, now published as the BoA monthly manager survey, shows just about everybody (89%) sees the world economy recovering (and 56% seeing it a lot stronger). Nobody has much cash anymore—only 4% in Dec. It's obvious most are underweight bonds (56%), the lowest since March 2018.

The managers like commodities and are a net 18% overweight, the highest since April 2011. They also like US equities but less than before, with only 15% overweight. In contrast, they are 25% overweight in eurozone equities and a whopping 55% overweight in emerging markets, the most since Nov 2010.

According to the Mace News report, "While COVID-19 uncertainty remained the top tail risk for the tenth straight month, inflation concerns crept onto the radar screen for the first time in many months... Inflation expectations continued to rise, with a net 79% of fund managers looking for higher global CPI in the next 12 months. This compared to a net 75% in November and a net 66% with in October and September."

What worries the managers? This is slickly named "tail risk." Covid, inflation, fiscal drag, credit event and US-China trade war (in that order). In November, "tech bubble" was No. 2 on the list and "civil unrest was No. 3. The managers still see tech as the most crowded trade, with short dollar positions next and then long bitcoin. Long gold comes 5th.

As for when vaccines will start getting an effect, the managers say May 2021.

The global managers take care of a vast amount of money (217 panelists, with $576 billion in assets under management) so we should probably pay attention. The problem, of course, is they never see the earthquake coming, just like the rest of us. As an example, managers are wildly overweight emerging markets, presumably excluding Argentina and Turkey (or maybe not by now). But let one of the bigger EM's develop a serious problem and they will all flee.

No sooner did we summarize these findings than the FT makes the top story this morning the sudden and huge flow into emerging markets at the "most rapid clip in seven years, offsetting a record exodus from those countries' stock and bond markets at the start of the coronavirus crisis. Money is expected to continue pouring into the asset class in 2021, with several analysts forecasting a bumper year of inflows. But others warn that the economic outlook remains tough and that many businesses and governments will struggle to invest in productive growth.

The FT hired the Institute of International Finance to crunch the numbers. EMs lost $243 billion in the first four months of the crisis, but recovered $145 billion in November alone. The recovery is better than any other EM comeback after a crisis. See the chart. Just about everybody in the business concurs this is the way to go, but some warn "...that the rally fuelled by the abundant cash in search of investments and the optimism over an end to the pandemic could run out of steam," for several reasons. One is the pandemic itself, which (among other things) will slash government revenues and capital spending. One manager says "the ability of governments to generate growth will be restrained."

No one predicts a crisis. We do. It's tigers and stripes.

Politics: We keep waiting for the next outrageous Trump stunt, but our imaginations are failing us. We expect the pardons but surely he will lash out more strenuously. Here we are at the unknown unknowns again. Geopolitically, probably the worst thing out there is China creeping toward grabbing Taiwan while the US is not looking. Technically, the US does not "recognize" Taiwan, let alone have a defense treaty, even though Taiwan buys lots and lots of US defense goods, including aircraft (we do have a trade deal). China grabbing Taiwan is perfect for Trump; as a bully, he is a coward. He can intervene (saying you can't oust a president in wartime, which is not true) or stand aside, saying it's all Biden's fault because everyone knows the Dems are wusses and China wouldn't have dared when he was in charge. Either way, he can reclaim the spotlight.

We tend to think the hot spot will be the Middle East, but Trump doesn't want to be a president who not only got impeached, but started a war, so he will leave Iran alone. North Korea, despite belligerence, doesn't really know what it's doing. So, China it is, if it's anything.

Speaking of impeachment, the Time magazine persons of the year are Biden and Harris, of course, but we wish the noted person list could have included Ukrainian Pres Zelinsky, who had the guts to resist being strong-armed by the US bully.

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