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What To Expect As Stocks Close In On Record Highs

Stock Market

The animal spirits are on the prowl once again, and world financial markets are on a rampage. Forecasts of doom and gloom rippled through the markets late last year and set a decidedly negative tone for the current year. Financial markets, however, have been having none of it.

Driven by the fear of missing out on a historic bull run that could be on its last legs, investors keep bidding the markets to new highs and fueling an impressive rebound from last year’s lows. Indeed, almost all asset classes and regions appear to be in the pink of health as the second quarter of the year kicks off.

The MSCI All-Country World Index (MSCI ACWI) is up 13.2 percent since the beginning of the year as most volatility measures plummet.

Chinese stocks have been on a tear, with the large-cap-tracking iShares China Large Cap ETF boasting returns of 15.1 percent even as the latest economic data from the country came in significantly better-than-feared.

The MSCI Europe Index has racked up YTD gains of 11.2 percent, defying the surreal, game-theoretical political divorce that is Brexit. UK is by far the index’s biggest component with a weight of 28.4 percent.

The MSCI Emerging Markets Index has been on the mend, managing gains of 10.8 percent after crashing 20 percent last year.

Related: China’s $13-Trillion Bond Market Joins Global Index

Meanwhile, back in the US, the S&P 500 has tacked on gains of 14.4 percent in the year-to-date. The Index has been able to retrace about 90 percent of the September-December downmove, making a return to the September all-time high more likely than a re-test of the December low.

(Click to enlarge)

Source: MSCI

(Click to enlarge)

Source: CNN Money

Climbing a wall of worry

U.S. stocks seem to have quickly stabilized following a scare a few weeks ago after the long-term Treasury yields dipped below short-term ones aka yield curve inversion.

Meanwhile, whereas there’s no shortage of drama in Washington, some of the most important political risks lie on the other side of the Atlantic. Brexit snafu seems to get worse at every turn and there’s a real danger that the UK might exit the bloc without a deal after lawmakers not only rejected May’s third proposal but also turned down all four alternatives.

The economic reality of Brexit is likely to be bad news for the markets no matter how you slice and dice it. The UK government has estimated that the country’s economy will shrink 3.9 percent over the next 15 years after it exits the EU. A hard Brexit and you are looking at a 9.3 percent contraction over the timeframe. That’s certainly terrible news for Britain, and that could rapidly spillover to the region and eventually the world. It could potentially get even worse than that.

As SEC chairman Jay Clayton has warned:

“The potential adverse effects of Brexit are not well understood and, in the areas where they are understood, are underestimated.”

In other words, the reality of Brexit might only fully hit home after the event.

Related: How Will New Basel Banking Regulations Impact Gold?

Nevertheless, the markets remain largely upbeat for one big reason: there’s an increased likelihood that the US and China will finally be able to strike a trade deal that will stabilize world economies and boost corporate earnings.

James Paulsen, the chief investment strategist at Leuthold Group, has put it succinctly, saying new highs remain ahead since a wall of worry has so far prevented excessive optimism from ruling the markets.

It is, however, imperative for investors to still hedge their bets appropriately.

Indeed, Moody’s Analytics Chief Economist Mark Zandi has warned there’s a high likelihood the global economy will sink into a recession if the Washington and Beijing fail to strike a deal over the next few months. Mohamed El-Erian, chief economic advisor at Allianz, has advised not to put all your investment into stocks and/or bonds but to have some cash ready. He has also said to be ready to be more agile than you probably have been in the past.

A good place to look for signs of trouble is the transportation sector. These stocks are economically sensitive than most and can be used as a leading indicator to predict where the stock market could be headed.

By Alex Kimani for Safehaven.com

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