Do not hold your breath for a US stock market catch down

Summary

The back to school global stock market sell-off continues but is unlikely to narrow the performance gap between U.S. markets and global shares any time soon

Back to school sell

The return to normal activity and volume levels after recent breaks on both sides of the Atlantic continues to be used as an opportunity to lighten up on stocks. One of the more important questions this revives currently is whether or not the latest episode could mark the end of a divergence between U.S. markets and those in just about every other distinct region elsewhere. One widely accepted reason as to why the S&P 500 index (for instance) has outperformed most pivotal Asia-Pacific, European, and emerging market indices is that U.S. shares are perceived as least-exposed to the immediate fallout from international trade disputes. The other key element to the deviation (some of which we chart in Figure 1 below) reflects economic pain wrought on countries with large dollar-denominated debts by rising financing costs as the Fed continues on its almost solitary tightening path.

A blip in history…

Imagining ourselves reviewing this divergence as recent history it makes sense to anticipate it will have been relatively fleeting. The prior most similar occurrence of a disparity between U.S. markets and regions elsewhere occurred roughly between the autumn of 1994 and spring 1995, another period marked by a Federal Reserve tightening cycle. We claim little visibility into whether or not the Fed will change the intensity of its hawkish policy due to an unmistakeable economic moderation as per 1995. However, we do expect that the symbiotic relationship between the White House’s combative approach to trade, tighter monetary policy and the U.S. dollar will eventually begin to bite U.S. corporations and stocks as much as investors currently expect these factors to hurt equity markets elsewhere.

…when we get there

Still, the key word is ‘eventually’. Evidence that trade, greenback, and financing cost pain are not yet evenly distributed continues to stream in. For a recent example see Tuesday’s ISM manufacturing PMI data, which brought the strongest headline print since 2004. The chances that the remaining top-tier data of the week, U.S. monthly employment data in particular, will paint a different picture also looks low, against a backdrop of recent important readings that, on balance, play strongly to the narrative that the economy remains comfortably on cruise control. Additionally, near-100% Fed fund futures implied probability points to another 25-basis point rate rise later this month. Implied probability for another hike in December trade well above 70%. The tightening rates market is partly reflected by marginal re-steepening of the yield curve between 10-year and 2-year U.S. Treasuries this week. The 10-year yield touched 2.9% on Tuesday, the highest since 10^th August.

S&P has catching down to do

At the same time, whilst the S&P 500 is on course for its first weekly loss in four, the frequency of its weekly falls has yet to match those in markets we defined above and as illustrated below. It is unlikely that bearish downdrafts can gather much momentum in U.S. markets until investors become concerned that selling could become more consistent. Meanwhile, there could be inflection points over trade relations between the States and China this week. Similar junctures earlier in the year punished markets of U.S. partners more. The S&P 500 had tacked on more than 8% over the year to date by Tuesday’s close compared to, for instance, a 19% fall by MSCI’s main emerging markets index for Europe the Middle East and Africa. Whilst it is by no means certain that U.S. stock market price returns can maintain or even widen the gap to underperforming overseas counterparts, a substantial ‘catch down’ by U.S. equities in the medium term looks a long shot.