Watch out that those wings do not melt

JP Morgan strategists claim the stock market has more to run, while Goldman’s says the best days for returns are behind us, I guess that’s what makes a market. The IMF proudly claimed in its latest assessment of the global economy that the ” battle against inflation has largely been won,” with average global rates settling at 3.5% next year, lower than the average between 2000 and 2019. This is a pretty sweeping statement: the price of Gold at record highs might be telling us something slightly different. They also upgraded growth expectations for the UK economy ahead of next week’s much anticipated and, some would say, feared budget. The IMF said UK growth would pick up to 1.5% in 2025 as falling inflation and interest rates stimulate domestic demand. They also predict the global economy will grow at just over 3% next year as interest rates continue to fall. That, I guess, is the continuing bull case for stocks, but are we becoming a little complacent?

I recently pointed out that US inflation expectations, as defined by the five-year five-year swap calculated by comparing TIPS yields with nominal Treasury yields, have been on the rise. Yesterday, US treasury yields rose again; one can once again get just over 4% by owning 2-year US treasuries. The ten-year yield is back above its 200-day moving average. Cuts in US interest rate expectations have been receding. The market is now starting to price in the possibility that we do not get two more 25 basis point cuts in the US by year-end. As pointed out in a piece from Absolute Strategy Research, the spread between high-yield credit and investment grade is about as tight now as it was in 2008 and has only been tighter, as one can see from the chart attached in 2000, an excellent illustration of the optimism we see for the outlook for riskier assets at present.

Recent fund flows continue to suggest optimism for the stock market, based partly on increasing optimism for the outlook for this earnings season, which, so far at least, has been a tad mixed, along with increasing optimism that Trump will triumph next month. Stocks in the US are not cheap, and due to the recent rise in bond yields, the equity risk premium has narrowed once again close to historic lows. Yesterday, US stocks looked like they would open weaker, but in the end, they clawed most of their losses back; consumer staples were the top performers, and industrials were the weakest.

So what’s the conclusion? I fear we are due a correction; some technical indicators also suggest the same. As the saying goes, it’s time to get a little fearful when others get greedy. Do I fear some significant sell-off? No. If the stock market did show signs of a major correction, central banks have plenty of room to cut interest rates, That is all assuming that the IMF is correct and that the inflation battle is won, but we are getting a little ahead of ourselves, particularly in the US, quite possibly.