A premature rally, says Barclays Wealth

Equity markets had their best week for some months last week, with the S&P 500 gaining close to 10%, note Barclays Wealth analysts. The return of risk appetite was spurred by a rally in the financial sector. This improved sentiment spread to other cyclical sectors with the materials, industrials, and consumer discretionary sectors all posting double-digit gains. Not even the downgrade of General Electric from its much-prized AAA credit rating could dampen the mood of investors, with the stock rallying 10% following the announcement.
The equity rally comes as little surprise, as markets were looking heavily oversold, but we do not see this as the start of a sustainable bull trend. Despite the rally, equity markets are still down 15% this year which is a reflection of the dire state of the world economy and the likelihood of further earnings downgrades over the coming months. This remains an unfavourable environment for markets, so don’t be too surprised when the current rally peters out.
Meanwhile, the World Bank suggests that global trade growth is likely to be at its weakest since the 1930s this year. That said, macroeconomic news is at least no longer just one-way traffic, with some good news too – particularly in China and, to a lesser extent, the US.
Looking at the US, retail sales came in well ahead of expectations for the second consecutive month in February and there were large upward revisions to the previous month’s numbers. Whilst motor vehicles sales continue to plummet, there were broad-based gains elsewhere, with a notable increase in spending on discretionary items. US consumers seem to be deriving some benefit from lower gasoline prices and lower headline inflation, together with reduced tax payments. It must be said however that the outlook for consumer spending still looks quite grim, amidst rising unemployment, falling house prices and the loss of financial wealth.
In China, the government’s stimulus programme enacted late last year is beginning to bear some fruit, but exports remain hard hit by the fall in demand from Western economies. Exports fell at a year-on-year rate of almost 26% in February and unsurprisingly industrial production growth remains extremely subdued at just under 4% year on year. That said, the rate of decline in import growth slowed from over 40% year on year in January to 24% year on year in February. This suggests that the government’s stimulus efforts are beginning to boost domestic demand. Indeed, bank lending has accelerated sharply over recent months and urban fixed asset investment was much stronger than expected in February, increasing at an annual rate of 26.5%. Particular strength was evident in central government investment spending, notably in areas such as railways and coal mining. This is likely to help offset some of the weakness in capital expenditure in export-related industries over coming quarters.
Outside of the US and China, however, economic data remain extremely gloomy, especially in export-dependent economies such as Japan and Germany. In the former, machinery orders (a good lead indicator of capital expenditure) declined at an annual rate of 40% in January, whilst the related series for Germany registered a similar pace of decline. Further sharp declines in both countries’ GDP are likely in the first quarter and their eventual recoveries will lag those of the US and China as a result.
“So, while the better tone of data from the US and China is undoubtedly welcome, it is clear to us that it is still too early to expect a sustainable equity market rally,” note Barclays Wealth analysts.