De-escalation: Covenant’s Weekly Market Synopsis

October 14, 2019

 

  • Last Week Today – A summary of news impacting the financial markets and the economy.
  • Financial Markets – An update of the week’s action.
  • De-escalation – Tensions b/w the U.S. and China leveled-off … for now.
  • Eco Data – The good and bad in recent economic data.
  • People Are Funny – Cleverly named stock tickers outperform.

Last Week Today. The World Bank updated its forecasts and announced that 2019 global GDP may not meet their already lowered 2.6% forecast. | The Fed minutes from the September meeting were dovish, reinforcing the likelihood of another interest rate cut at their next meeting on October 29th/30th. | An Iranian tanker was hit by missiles in Red Sea waters off the coast of Saudi Arabia, causing oil prices to briefly rise and heightening the conflict between Iran and Saudi Arabia. | The Federal Reserve announced it will purchase $60 billion a month in short-term Treasury bills through at least the end of Q2 2020 to ensure smooth operations in the overnight repo market (i.e., intrabank lending) that experienced a liquidity squeeze last month.

Financial Markets. Equities broke a three-week losing streak, as positive trade news pulled markets higher at the end of the week. But the more important story was the rise in bond yields, as the yield curve became less inverted. The closely watched yield differential between bonds maturing in 10 years and 3-months finally unkinked when the benchmark’s 10-year note yield rose to 1.75% above the 1.68% yield on the 3-month bill. This doesn’t mean we’re out of the woods with regards to a future recession. However, the economy functions better when the credit markets are working normally, and when the curve is not inverted, banks are more incentivized to lend. Equity flows continue to be negative as investors pull money to invest in bond funds, which have already racked up impressive gains (the iShares 20+ Year Treasury Bond ETF – TLT – is up more than 15% YTD). According to BofA Merrill Lynch data, investors have pulled $217 billion from equity funds and plowed $379 million into bond funds in 2019 – this is often seen as a contrarian indicator that is positive for stocks. The third-quarter earnings season gets underway next week, which will help determine the direction of stock prices. Like the last two quarters, earnings in the aggregate are expected to decline. However, in each of the previous two quarters earnings actually rose modestly, which is saying something given tough comparisons to last year when fiscal stimulus and tax cuts boosted corporate profits. For a summary of weekly, month-to-date, and year-to-date financial market performance, please click here.

De-escalation. While it’s been well-covered, it would be disingenuous not to include U.S. / China trade negotiations in this synopsis of financial market and economic events since their impact on the markets was so visible. My colleague and I likened it to a tennis match where your head is on a swivel looking this way then that as the players drive the ball back-and-forth. China opened the week with an aggressive serve, narrowing the scope of topics Chinese officials would be willing to negotiate during discussions later in the week. Equities declined on Monday. The U.S. returned China’s serve and went crosscourt, blacklisting eight Chinese technology companies, accusing them of involvement in human rights violations of Muslim minorities and resurfacing the idea of restricting U.S. investments into China. Equities fell further on Tuesday. China then lobbed the ball back over the net, saying they would be open to a small trade deal if President Trump backed off on tariffs. Equities rose on Wednesday. It looked as if the match was over on Wednesday evening as equity futures plunged when it was reported that Chinese negotiators were leaving Washington a day early without a deal. Then, within a couple of hours, the ball came back across the net (and futures recovered) as that report was said to be false, and a deal was still possible. As news of a deal began to leak on Thursday, equities rose, and when the deal was announced on Friday, they rose further. Apparently, U.S. and Chinese negotiators met at the net, shook hands, and walked away from the match exhausted, each claiming victory. The reality is that little was accomplished in resolving the trade dispute. However, the fact that negotiations did not collapse resulted in a de-escalation of tensions, at least for now. The market welcomed the news, but this is far from over, and risk assets hang clearly hang in the balance. I’m not a political strategist, but if I were President Trump and I was planning to make a deal with China, I would wait until closer to the 2020 election. Voters have short memories, and the favorable political currency from striking a more significant deal with China before mid-year would likely have little benefit at the polls next November.

Eco Data. There’s good news and bad news in recent economic data. Let’s end on a good note, and start with the bad news, which is not exactly bad and better categorized as “concerning and worth keeping an eye on.”

Labor Market: While the unemployment rate remains extremely low, a troubling trend in job openings has emerged, which may slow the pace of hiring in the future. Since last November, job openings have declined by 7.5%, which is highly unusual in an economic expansion. During the slowdown of 2015/2016, they declined by 0.8%, but the last time job openings fell by 7.5% was between March 2007 and December 2007 just before the Great Recession. The decline in openings could partially be explained away as there have been more jobs available than workers to fill them, but on the recession dashboard, this indicator is flashing yellow. A strong labor market is critical to a healthy economy, especially in the U.S., where consumers comprise 70% of GDP.

clip_image001

Sources: FTN Financial and the Bureau of Labor Statistics.

Business Investment: Capital investment by businesses is flat year-over-year, even as low interest rates make financing equipment purchases historically cheap. However, a sluggish global economy and uncertainty around trade make planning for the future a challenge, and in response, managers are keeping their hands in their pockets.

clip_image002

Sources: FTN Financial and the Census Bureau.

Residential Housing: Housing is finally showing early signs of a rebound, as lower interest rates are improving affordability. New home sales rose 28% following a 2.5-year decline that ended last October. Existing home sales remain slightly below their 2017 peak, but have risen 11.4% since January. Before this quarter, residential investment had recorded six consecutive quarters of negative growth, but that disappointing streak may be coming to an end. A stronger housing market is good for the economy because it has knock-on effects in related services and goods sectors.

clip_image004

Sources: FTN Financial and the Census Bureau.

clip_image006

Sources: FTN Financial and the National Association of Realtors.

People are Funny (if not predictable). Through our series on Behavioral Finance (which we will continue in the coming weeks), we’ve looked at how the hardwiring of the human brain makes people susceptible to errors in judgment. Below is just a fun example of how familiarity breeds comfort, and comfort promotes risk-taking. When a company offers stock to the public through an initial public offering (“IPO”), management chooses a ticker to identify the company on the stock exchange. As the chart below highlights, companies who select clever or recognizable words as their tickers have outperformed the stock market by a wide margin over the last 10 years. Some of the outperformance is undoubtedly related to better corporate earnings, but don’t underestimate the power of easy to remember tickers when investors select stocks to purchase. Indeed, while the broader market has doubled over this timeframe, “clever” ticker name stocks have soared in value by nearly 5x.

clip_image007

Be well,

Jp.