Why the markets trends reversed in the last two weeks? - BBH

Research Team at BBH notes that at the current environment an important question is why the markets trend reversed in the last two weeks and there appear to be two answers.  

Key Quotes

“The first is “buy the rumor, sell the fact” type of activity following the Fed's rate hike on December 14.   If this is the case, investors should expect a continued unwinding of those trends.  On the other hand, if it was just a short-term pause in trends as books were closed, then the underlying trend may be expected to reassert itself.”

“Our understanding of the technical condition favors the first scenario, and look for the broader correction to continue.  Participants may be slow to return and may wait for the US employment data.  The holiday break may have also served to psychologically break the strong momentum that had built.  Given that the ECB and Fed moved in December, Q4 data may have lost some of its ability to impact investment decisions.  Psychology and positioning may be more important drivers than economic data as the New Year begins.”

“In the big picture, we expect the dollar's uptrend to continue, driven by the divergence of monetary policy broadly understood and the political risks emanating from Europe.  On different valuation calculus, the European equities may look relatively cheaper than the US or Japanese stocks.  There may be good macroeconomic reasons for this, but our point is that the interest rate differentials are such that one is paid for hedging the euro and yen (several other foreign exchange exposures) back into dollars.  Consider that in Q4 16; the Nikkei rallied 16.2% while the yen fell 13.4%.”

“The Eurozone economy is growing near trend, which is often estimated to be around 1.25%-1.50%.  The problem, we are told, is prices.  Assuming that the services PMI is in line with the flash reading, then the midweek's CPI data are likely to be the most important of the week.”  

“Due primarily to the base effect from oil, headline Eurozone CPI is expected to rise to 1.0% from 0.6%.   It is not that high since September 2013.  Recall that from February through May it was in negative territory.  The core rate, on the other hand, is expected to be steady at 0.8%, where it has been since August.  It bottomed in the first part of 2015 at 0.6%.  There has yet to be any traction in the core prices, and this is one of the things that cannot set right with ECB's Draghi.”

“It is not ideal, but one way that the periphery of Europe can gain competitiveness on Germany is if they can experience lower inflation than Germany.  This was a problem when German CPI is near zero, as other countries either experienced deflation or lost competitiveness to Germany.  However, now German inflation is set to rise quicker than others.   German state CPI readings so far have come in higher.  The national reading will be reported later today and is expected to rise 1.3% y/y.  French CPI ticked higher to 0.8% y/y, lower than the 0.9% expected.”