Inverted and Underwater

361 Capital Market Commentary | August 19th, 2019

The markets finally snapped last week as softer economic data out of Germany and China combined with the meltdown in Argentina, protests in Hong Kong and additional cardiac arrests in U.S retail company earnings, pushed investors to the limits. The U.S. yield curve not only fully inverted, but U.S. ten-year yields traded below 1.5%. Around the world, most global bond markets traded to all-time low yields which also happened to be negative. This is not normal or healthy for the global economic outlook.

The White House tried to help the markets by delaying the China tariffs on some goods until December, but both countries remain reluctant to sign or even negotiate a trade deal right now. Especially with the Huawei and Hong Kong pawns now sitting on the trade deal chessboard. For the White House to score points with the stock market from here, it will need to provide some well thought out solutions for how it will deal with this economic slowdown as it rolls through the U.S. States. No more Tweet-attacking the Fed or chest pounding past economic data. U.S. interest rates are headed toward zero and that is a massive warning flag. Time to garage the golf cart and find some fixes before U.S. workers start losing their jobs and look to place blame.

The big events this week will be another round of U.S. retail earnings, a full day of global PMI updates and then fly fishing with the Fed in Jackson Hole, WY. The big day of speeches at that event will be on Friday. Expect plenty of talk setting the stage for another rate cut in September. The real game will be how to place bets for the size of the cut. Right now the markets are betting on 25 basis points with only about a 25% chance at a 50bp cut. This should be one of the livelier Jackson Hole conferences in years. Enjoy it if you are heading out.

And if enjoying the Wyoming wilderness, be careful as Tom will be out bear hunting…


Thomas Lee Tweet

$1.9 trillion in world market cap disappears last week as global data slows further and recession fears build…


Bloomberg World Stock Mkt Cap

German Q2 GDP goes negative confirming everyone’s global growth fears…


German Gross Domestic Product

While another German survey suggests that the economy will slow further…


German ZEW Investors Expectations

The Wall Street Journal took their fight with Navarro and the White House to a new level last week…


We’ve been warning for two years that trade wars have economic consequences, but the wizards of protectionism told Mr. Trump not to worry. The economy was fine and the trade worrywarts were wrong.

But we never said tariffs would produce immediate recession. We said they—and the climate of uncertainty they were creating for business—would chill global trade and undermine the surge in capital investment spurred by tax reform and deregulation. The growth momentum from tax cuts and a strong labor market were able to mask the impact of helter-skelter trade policy for a time. But that old economic disciplinarian, Adam Smith, sooner or later exacts a price for policy blunders.

Wednesday’s market moves are an omen of the future, not destiny. The key to avoiding the worst is to restore a sense of policy calm and confidence. Stop the trade threats by tweet. Call a tariff truce with China, Europe and the rest of the world while negotiations resume with a goal of reaching a deal by the meeting of Pacific nations in November. Someone should tell Mr. Trump that incumbent Presidents who preside over recessions within two years of an election rarely get a second term.


Greg Ip jumped in with a few downward elbow slams…


In the past month it has become clear that nationalists aren’t simply correcting globalists’ excesses; they aim to supplant them altogether. After two years of fruitless efforts to negotiate an exit from the EU with most commercial relations intact, Britain now has a prime minister, Boris Johnson, prepared to make a clean break by Oct. 31 no matter the economic cost.

Mr. Trump’s early protectionist strikes at traditional allies were contained by countervailing forces at home and abroad. But the collapse of trade talks with China foreshadows a more fundamental unraveling of rules of economic engagement between the world’s economies. Having abandoned for now efforts to write a new rulebook, the U.S. and China have resorted to ad hoc, brute-force tariffs, devaluation and retaliation, which Tuesday’s surprise tariff reprieve simply underscored.

Elsewhere, Italy’s deputy prime minister, Matteo Salvini, leader of the anti-EU, anti-immigrant League party, is seeking to bring down his own coalition in hopes new elections will put him in control of the government. A trade war is brewing between American allies South Korea and Japan over ancient, unhealed wounds. Argentina’s peso and stock market crashed this week when Peronists, whose history of populism and protectionism saddled the country with its current woes, became the favorite to form its next government.

For the past two years, the U.S. and world economies shrugged off nationalism and populism. Protectionism was contained and more than offset by positives such as Mr. Trump’s tax cut and deregulatory drive. It can no longer be ignored: Businesses and investors, unsure of what if any rules will govern international commerce, are retreating from risky investments.


Meanwhile, U.S. retailers could not be more confused about what anything will cost them for this holiday season…


Just over three-quarters of shoes, apparel and home textiles such as tablecloths and bed sheets that are imported from China will be subject to a 10% levy as of Sept. 1, according to data shared with Bloomberg News by the American Apparel & Footwear Association, an industry promotion group. That’s in spite of President Donald Trump’s plan to spare holiday shoppers the impact of higher prices by delaying some of the tariffs until Dec. 15.

“The fact that all the headlines are saying the administration ‘saved Christmas’ is just creating more confusion. This is not the case,” Steve Lamar, the executive vice president of the industry group, said in an email. “The majority of our products will be hit with a higher tariff bill on September 1.”

Lamar said the tariffs amount to a new tax on U.S. businesses and consumers.


And consumers are also getting increasingly worried about conditions…


Consumer Sentiment UMich Current Conditions

Cantor Fitzgerald becoming more skeptical about the outlook for U.S. Earnings…


According to data provided by Factset, the estimate for Q3 EPS growth has now fallen to a 2.4% contraction, down from the 2.6% growth expected at the end of March. Looking at Q4, in the course of the last week, EPS growth expectations dipped to 4.5% from 5.4%, and down from 7% expected two weeks ago (and down from the 8.7% expected at the end of March). As we have continually contended, we see the likelihood of a ‘hockey stick’ Q4 recovery extremely unlikely, and this is starting to play out. For the full year, EPS is now expected to only grow 2.3%, and estimates continue to fall. As we posited in our 2019 Outlook, the S&P would likely be in an earnings recession in 2019.

Meanwhile analysts continue to lower their company earnings estimates for another week…


Remember, stocks follow earnings.

2019 SP 500 EPS Growth Estimates

Not much fun reporting the numbers of John Deere right now…


Deere cut its net income as well as its construction & forestry equipment sales forecasts for the full year; the guidance is below analyst estimates. The company sees FY net income about $3.2 billion, below the estimate of $3.29 billion. The company reported 3Q adjusted EPS $2.71, below the estimate of $2.84 and 3Q net sales $8.97 billion, below the estimate of $9.38 billion. The company stated “John Deere’s third-quarter results reflected the high degree of uncertainty that continues to overshadow the agricultural sector… Concerns about export-market access, near-term demand for commodities such as soybeans, and overall crop conditions, have caused many farmers to postpone major equipment purchases.”

Global PMIs drop next week. Downward trends will likely extend lower…


Global PMI
(Cantor Fitzgerald, Bloomberg)

So where is the silver lining in all of this bad news? Bond prices are going to infinity and beyond!


Market value of negative yield bonds

More support for the U.S. Dollar as global investors buy our #1 export: Positively Yielding Bonds…


US share of global IG fixed income yield

And of course the U.S. Treasury should be sprinting to issue 50-100 year paper right now…


With interest rates on 30-year U.S. debt hitting all-time lows this week, the government is once again considering whether to start borrowing for even longer.

The U.S. Treasury Department said Friday that it wants to know what investors think about the government potentially issuing 50-year or 100-year bonds, going way beyond the current three-decade maximum.


30-year Treasury yields sank to a record low

Of course, record low yields are terrible news for banking and financial companies…


Bloomberg Europe Banks and Financial Services Index

Meanwhile, the highest yields on the shortest maturity Treasury paper is not good for stock prices…


SP 500 Since 1990

We are still watching credit closely. So far, only the junk is looking uglier…


CCC vs HY Spreads ex HY Distressed Index since election

Blame the Energy sector for the pain in junk bond land…


US Energy Junk Bonds

So the Germans are about to try something very un-German…


Germany is going to shift from austerity toward its own mini-Marshall plan. This has really excited the markets the last few days.

This is how the plan is supposed to work: First, the KfW would issue a so-called global loan to its Spanish sister bank, the ICO. These funds would then enable the Spanish development bank to offer lower-interest loans to domestic companies. As a result, Spanish companies would be able to benefit from low interest rates available in Germany.

Under the plans, Germany could also invest in a €1.2 billion ($1.6 billion) venture capital fund that could be used to support new business activities. Madrid hopes that the program will generate a total of €3.2 billion in new investment.

The agreements with Spain are intended to serve as a blueprint for similar aid to Portugal and possibly even Greece. How high the payments to these countries will be has yet to be determined. “It will be nothing to sneeze at,” say Finance Ministry officials. The German government envisions spending a total in the single-digit billions on the program. Schäuble plans to fill in the budget committee in the German parliament, the Bundestag, next week.


With all the news, it was a significant risk-off week for the markets…


Take notice of the Long Treasury ETF running the table on Equities YTD.

Returns 8-16-2019

Same among the Sector ETFs with Staples, Utes and REITs posting gains…


Nice bounce in Semis last week thanks to the Nvdia earnings beat and outlook.

Returns 8-16-2019

Local expertise suggests that Hong Kong is done…


For the last few months I have been relentlessly asking everyone I know in Hong Kong or who used to be in Hong Kong or who at one time contemplated setting up a business in Hong Kong how what has been happening in Hong Kong has and will or would impact their doing business in Hong Kong. Based on those responses and on my own experience with how international companies operate, I foresee the following:

1. Companies that were deciding between Hong Kong or Singapore for their Asian headquarters will choose somewhere other than Hong Kong.

2. Growing companies with offices in Hong Kong and with offices somewhere else in Asia will increase their hiring outside Hong Kong and decrease or eliminate their hiring in Hong Kong.

3. Companies with offices in Hong Kong and with offices somewhere else in Asia will be move personnel from their Hong Kong office to their other offices.

4. Fewer contracts will be drafted with Hong Kong as the venue for arbitration.

5. Companies will move their Hong Kong bank accounts elsewhere. It is no coincidence HSBC stock hit its 52 week low today.

6. Travelers will choose somewhere other than Hong Kong as their Asia stopover. It is no coincidence Cathay Pacific stock hit its 52 week low today.

7. Many Hong Kongers will eventually go elsewhere.

I am not saying any of the above will be noticeable tomorrow or even a month from now, but I am saying that all of the above have already begun and all of the above will accelerate once China’s army goes in at full force, which is pretty much inevitable. Within two years Hong Kong will be a very different place than it is today and within five years it will hardly be recognizable for those of us who have been there within the last five years.


WeWork got worked last week…


But from an investment perspective, the mismatch in assets and liabilities is all that you really need to analyze.

Mismatched durations. The founder of Kohlberg Capital, Jim Kohlberg (total gangster), taught me investment firms go out of business because of “mismatched durations.” It’s about raising money short (customers who can stop buying your product service soon/tomorrow) and investing money long (10-year leases). WeWTF is an especially risky business going into a recession, when the ability to variabilize costs is limited, but revenue decline is unlimited. WeWTF has $47 billion in long-term obligations (leases) and will do $3 billion in revenue this year. What could go wrong?


Finally, geek humor turns into hell for one Californian…


In late 2016, Tartaro decided to get a vanity license plate. A security researcher by trade, he ticked down possibilities that related to his work: SEGFAULT, maybe, or something to do with vulnerabilities. Sifting through his options, he started typing “null pointer,” but caught himself after the first word: NULL. Funny. “The idea was I’d get VOID for my wife’s car, so our driveway would be NULL and VOID,” Tartaro says.

The joke had layers, though. As Tartaro well knew, and as he explained in a recent talk at the Defcon hacker conference, “null” is also a text string that in many programming languages signifies a value that is empty or undefined. To many computers, null is the void.

That setup also has a brutal punch line—one that left Tartaro at one point facing $12,049 of traffic fines wrongly sent his way. He’s still not sure if he’ll be able to renew his auto registration this year without paying someone else’s tickets. And thanks to the Kafkaesque loop he’s caught in, it’s not clear if the citations will ever stop coming.


California NULL

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