Markets are preoccupied by current political turmoil. Brexit, China-US trading, expectations of declining trade globally, short-term resolution to shutdown in US, European vows. The list could be easily extended. Markets have often a subtle way to look through the vail of noise and pick the write route despite all the uncertainty. Two, often overlooked developments, appear to be in making. Emerging markets and European cyclical sectors are outperforming. Counterintuitive. Slowing economic growth expectations, China slowdown, monetary policy jitters just to name but a few do not generally inspire cyclical investing. Nonetheless the market wisdom shows an unexpected turn of events.

Advanced cyclical index Europe vs MSCI Emerging Markets Index

Cyclicals

Source: Bloomberg, Stoxx Limited, Advanced Dynamic Asset Management

Rising US yields

US 10 year government bond generic yield

10y bond yield 2018-10-04

Source: Bloomberg

Steeper yield curve in the US

US 3 months vs. 10 years yield curve

us curve 2018-10-04

Source: Bloomberg

Better economic numbers

ISM Non-Manufacturing Sept 2018

ISM 2018-10-04

Source: Institute for Supply Management, Bloomberg

All this unsettles the equity markets. Too much good. It is easy to argue that the good time will not last and the correction in equity markets will finally happen. All so true.

The time is the hard issue. Timing has always been a challenge especially in bull markets. The time tested indicators may be flashing some yellow warning signs. However, as so often they may be early not by weeks buy quarters. Just entering some of the best period in the market history.

Fourth quarter of a calendar year till the end of the second quarter are generally strong.

This period particularly into the pre-election year shows even stronger performance.

season 2018-10-04

Source: Oppenheimer & Co., Bloomberg

Well behaved Federal Reserve with clearly communicated policy.

Global central banks showing tolerance for higher inflation.

Trade disputes making it all look sour is arguably a long shot.

Markets are afraid of the news to their own peril. Fundamentals last longer than news.

 

There is a constant barrage of news from Europe which is very uninspiring. Brexit unresolved and running into time constrains. Italian government continuously threatening the EU. Again italian government which intends, mostly, to turn its back on austerity and undertake extremely populist measures to hopefully stimulate the economy. Trump and the various threats of tariffs. Turkey economic and currency crises. Just to mention the issues closer to European heartland.

Any positive economic news has been disregarded. Negative economic numbers are watched and discussed very close as indicator that might strengthen the feeling of fear and the inevitable things to come.

The following charts demonstrate the current state of affairs in Europe very well. DAX appears to be building a head and shoulder reversal formation. It is not ready yet as the index did not break lower from here to finally confirm that the structure is in place.

DAX weekly chart

DAx 2018-09-07

Source: Bloomberg

All investor hope that Europe and particularly Germany is not following into the emerging markets path.

September tend to be a very weak period for the equity markets and it appears that this year again it repeats a very long standing pattern. There is still hope that the economic trends will not turn negative and drag the markets lower. The yield curve is not inverted which happens often ahead of major market correction.

We are watching all those indicators which are still constructive. The fear of the unfamiliar political turmoil in Europe and abroad could still become self-fulfilling prophecy and the market in Europe deepens the current correction.

If, on the other hand, investors follow some fundamental indication and valuations, we may be able to escape the worst. DAX is close to the cliff but did not jump yet and there are good reasons, why it can still pull away from the edge.