Why There’s a Disconnect Between Economic Data and Performance

Recent weak economic data have confirmed everyone’s worst fears: The global economy is indeed decelerating.

Yet last week, according to Bloomberg data, nearly every economically-sensitive asset class advanced, including U.S. stocks, commodities and high yield. This is a change from the past several months, during which trading has been largely driven by a negative reaction to the growing evidence of a global slowdown. So, why the disconnect now?

As I write in my new weekly commentary, “Stocks Push Higher, But Earnings May be a Roadblock,” in a world in which both fiscal and monetary policy are constrained, investors are justifiably excited over any development that holds the prospect of boosting global growth, if only over the long-term. Last week brought one such development: the tentative Trans Pacific Partnership (TPP) agreement.

After years of tortuous negotiations, trade negotiators agreed to the outlines of the TPP, an extensive trade agreement that goes well beyond tariff reduction. The initial 12 countries in the TPP, including both the U.S. and Japan, comprise 26 percent of global trade, as Bloomberg data show. The pact will gradually lower trade barriers to goods and services as well as set common standards for trade, investment and labor.

Beyond the TPP, the big driver of last week’s market action, investors also latched on to any theme that might be a positive for the economy or stocks, including dovish Fed minutes and some stabilization in the Chinese currency.

Looking forward, however, the risk-on rally probably won’t last. While volatility has temporarily subsided, market focus is now likely to shift back to U.S. earnings. Analysts are expecting a profit decline in the third quarter, according to Bloomberg. Absent an unexpected improvement, or at least more positive guidance for fourth-quarter earnings, the recent rally in U.S. equities is likely to be contained.

Given this, investors should look elsewhere for opportunities, including to Japanese stocks and high yield bonds. While the TPP deal will do little to boost Japan’s economy in the short term, it’s a significant positive for a country struggling with long-term growth issues. Meanwhile, the recent widening of spreads has returned value to the high yield sector.

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.

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