With the ECB announcing the end of QE, and the Fed in the process of reducing its balance sheet, there will be substantially less free money available to drive the valuations on U.S. stocks. Meanwhile, some of the uncertainty that has riled E.U. markets in recent months is starting to subside.
Consider the following:
- Italy’s 10-year government bond yield fell below 3% for the first time since September after a government official said that the proposed budget deficit would be revised from 2.4% to 2%, which would be more in line with E.U. demands. Ten-year yields have now fallen more than 60 basis points from their highs in mid-October, indicating that markets believe the worst of the uncertainty may be over.
- In the U.K., Prime Minister Theresa May won the vote of confidence called by her party, but whether or not her Brexit deal gets off the ground remains to be seen. In any event, the pound sterling rose 1.4% yesterday, immediately before the vote, as it became clear she would likely win. Her victory appears to have a couple of important implications: 1) it effectively diminishes the chance of a disorderly “no-deal” Brexit; and 2) it raises the possibility that a full parliamentary confidence vote will be called, which could open the door to a second referendum.
As tortured and uncertain as the process has become, the silver lining is that it should prove an effective deterrent to other countries that might consider leaving either the E.U. or the common currency.
- In Germany, the election of Annegret Kramp-Karrenbauer to replace Angela Merkel as leader of the CDU could prove to be a bulwark against the Social Democrats (SPD) as well as fringe parties. Uew Jun, professor of politics at Trier University, told the Financial Times: “In terms of the competition between the two parties, Kramp-Karrenbauer will make life more difficult for the SPD. She represents the social wing of the CDU and her positions on social and economic issues are pretty close to the SPD. This could make it even harder for the SPD to draw a distinction to the CDU—and that was already a problem for the party.”
- In France, Macron has been put to the test with the “yellow vest” protest movement, which prompted concessions on government benefits. The Financial Times had this to say in a December 12th Op/Ed: “What is vital is that this tactical retreat does not become a strategic one that spells the end of the Macron project. The risks are substantial. But there were some positive signs in the president’s televised address on Monday. He was right to lower his gaze, for now, from the EU horizon to put a clear focus on domestic reform. Despite the budgetary impact, he was right, too, to offer measures to improve living standards for the less well off, such as boosting the minimum wage.”
Later, the Op/Ed continued: “For the president to stand any chance of pressing on with his most ambitious plans, such as pension reform, he needs to convince the left-behind of France’s rural regions, small towns and deprived banlieues that he heeds their concerns and is determined to carry them with him. On Monday, Mr. Macron at least made a start.”
The following chart points to early signs that a base might be forming in the Stoxx 600 index relative to the S&P 500, ever since the S&P hit its all-time high in September. This is noteworthy because for the past several months, the political and economic news has been uniformly negative, not to mention the toll that the trade war has taken on the region’s economies. If the bad news has been fully priced-in, then it wouldn’t take much positive news to turn sentiment in the other direction. The aforementioned political events could be providing important clues in this regard. Any sign that the R/S line is pulling off current levels could be an important signal that the worst of the capital outflows from Europe has ended.