This Summer is Over

361 Capital Market Commentary | August 5th, 2019

As the kids fill their backpacks with textbooks and head back to the classroom, investors are looking for a textbook to help them understand this rapidly changing investing environment. In less than a week, the climate changed from ‘maybe one Fed rate cut and done’ to ‘a full out Chinese trade and currency war’. Once again, how is anyone supposed to run a business under these conditions? This is definitely not an environment for increased capex spending or hiring decisions. And, with so much uncertainty, this is not a market that deserves to trade at a premium multiple. If you want to see the short-term flight to safety in action, just look at the four-day move in 10-year Treasury yields which collapsed 30 basis points! There hasn’t been a bigger four-day move since the Brexit vote in 2016.

While weak earnings guidance continued to throw shade on the market last week, it was the non-progress in the China trade talks, and the new layer of tariffs imposed by Trump and Navarro that threw the markets into the wok. Increased tariffs on most everything under a Christmas tree will cause a new round of higher costs for U.S. consumers. It also caused the Chinese government to stop purchases of all U.S. agricultural goods (goodbye farmers) and to devalue their currency (sorry U.S. manufacturers). Bottom line is that global trade will slow further and all boats will sink with the falling tide.

Where is the silver lining in all of this? Well, interest rates are clearly headed toward zero. The more that world trade slows, the closer the U.S. economy gets towards being in a recession. The Fed would like to avoid this so they will be forced to moved the Fed Funds rate even lower. We are certain to get another cut at the September meeting. The markets are even pushing the odds of a 0.5% cut toward 30%. So the bond markets should continue to march higher. Gold loves uncertainty, so it should continue to shine. Defensive stocks (Utes, REITs & Staples) should continue to outperform as stock portfolios look for safety and yield.

A hard ceiling now seems built in for stock prices. Let’s see how investors feel about the 200-day moving average, as well as the 3-month lows. We broke both of these levels hard when the trade wars, earnings uncertainty and the credit markets bit us back in October. This time we have a repeat of the trade wars and earning uncertainty, but are missing the credit break piece. So of course, I will tell you to keep a close eye on the credit and bank loan markets. If they snap then we will likely test another bear market pullback. One more silver lining to a 20%+ correction will be that Berkshire Hathaway, and all the private equity funds, can finally deploy those cash hoards without complaining about the prices paid.

The Bond markets flight to safety…

 

United States 1 Year Bond

Market worries accelerated over the weekend as the China trade war evolved into a China currency war…

 

Indeed, the flare-up in trade tensions has renewed global financial market concerns over how much China will allow the yuan to weaken to offset heavier pressure on its exporters.“It appears the Chinese authorities no longer see the need to limit the tools at their disposal and that the currency is now also considered part of the arsenal to be drawn upon,” Rob Carnell, chief economist and head of research, Asia Pacific at ING, said in a note.

Analysts have previously said that authorities will keep depreciation in check due to concerns about potential capital outflows.

Despite slowing economic growth over the past year amid the intensifying trade war, China has not seen a rush of capital flight, thanks to capital controls put in place during the last economic downturn and growing foreign inflows into Chinese stocks and bonds.

(Reuters)

USD CNH Inverted
(WSJ/DailyShot)

Along with a devalued Chinese Yuan, the U.S. Government will also need to contend with U.S. farmers losing their largest buyer…

 

China is stepping away from further U.S. farm imports after President Donald Trump ratcheted up tensions with its biggest agricultural trading partner last week.

The Chinese government has asked its state-owned enterprises to suspend purchases of U.S. agricultural products, people familiar with the situation said. Also, privately run Chinese crushers that had received retaliatory-tariff waivers on American soybeans from Beijing have stopped buying the commodity due to uncertainty over trade relations, other people said.

(Bloomberg)

CBOT Soybean Futures
(WSJ/DailyShot)

Holiday gift giving will also become much more expensive for U.S. consumers…

 

US imports from China of these 10 categories of consumer goofs represented nearly 270 billion in 2018
(Bloomberg)

And if you think that China is paying the tariffs, Plains All American Pipeline has some info for you…

 

Plains All American Pipeline LP said on Friday it will tack on a fee for users of a new oil pipeline to pay for the cost of the Trump administration’s tariffs on imported steel, with analysts and traders calling it the first U.S. energy pipeline operator to do so…

Houston-based Plains will begin charging shippers a 5 cents per barrel fee on its 670,000 barrel-per-day (bpd) Cactus II pipeline next April to offset higher construction costs from “governmental regulation and tariffs,” according to a filing with the Federal Energy Regulatory Commission.

Plains last year estimated the 25% steel tariff would add $40 million to its costs for the $1.1 billion pipeline, which runs 550 miles (885 km) from the Permian basin of West Texas and New Mexico, the top U.S. shale field, to the U.S. Gulf Coast.

(Reuters)

Mark Zandi says these tariffs push the odds of a U.S. recession to 50/50…

 

As Mark Zandi, chief economist at Moody’s Analytics, told CNBC, if Trump follows through on the tariffs, “that is the fodder for recessions,” and would more than likely force Powell’s hand, out of fear of the impact on business confidence and spending. (The new tariffs could also affect consumer spending, as products like Nike sneakers and iPhones will be affected.) But whether Trump is playing three-dimensional chess in an effort to get the rate cuts he wants, or is just being his usual not-very-bright self—and the odds are it’s the latter—the result will probably be the same. “Recession odds probably go over even,” Zandi said, “and I think it would be pretty hard to avoid a downturn, regardless of what the Fed does. The Fed will have to respond, and the Fed will have to cut rates. The bond market will get what it is anticipating, and that is four rate cuts.”

(VanityFair)


The one vs. ten-year yield curve is taking the over on a recession bet…

 

One of the markets most trusted recession indicators is at pre crisis lows
(Bloomberg)

Even markets are so worried that they are now seeing a 1 in 3 chance of a 50 basis point cut at the next Fed meeting…

 

@biancoresearch: Cutting 50 in September just hit 33%, my benchmark for saying it is “in play.” (this was 10% last night before China opened and 0% on Thursday That said, a cut by August 31 (which includes Jackson Hole/Burning Man) is still essentially zero.

Futures Fed Funds Effective

Over in Europe, the giant German yield curve joined the Swiss one in going completely negative…

 

Germany Government Bond Curve
(WSJ/DailyShot)

Even though it was a Jobs data week, the markets were talking about the Chicago PMI…

 

Sure the U.S. is now a Services economy, but when a major manufacturing index like this curdles, you have to take notice and plan accordingly.

Chicago PMI: 1968 - 2019
(@bespokeinvest)

It was also the final big week of corporate earnings…

 

And as expected, the guidance continued to disappoint. If fact so much that it took Q3 earnings growth guidance negative.

SP500 EPS growth expectations continue to drop
(@EarningsScout)

Goldman Sachs noted that this was not a good quarter to miss earnings…

 

Companies beating earnings estimates have outperformed by 143 bp on the day after reporting – in line with history. But the median firm that missed EPS estimates has underperformed the S&P 500 by 300 bp the day after reporting (vs. a median of 211 bp).

(Goldman Sachs)

Earning Impact - Stocks showing pronounced reactions to misses and beats
(Bloomberg)

A major risk-off week due to the acceleration in China trade wars…

 

But Bonds and Gold shine brightly.

Market 08-02-2019
(8/2/2019)

Across sectors, it was all about playing defense…

 

Sectors 08-02-2019

British heads will explode when learn that they are earning less than their Irish peers…

 

@aliceemross: Chilling FT graphic today – how poorer each person across Europe would be under a no-deal Brexit:

Brexit poised to sweep across Europe


Big read in Barron’s on retail…

 

The Bataan Death March might be a close parallel.

There are about 1,350 enclosed malls in the U.S., but only 200 to 400 are needed, says Randal Konik, an analyst with Jefferies. At malls and beyond, the U.S. had 23 square feet of store space per person as of last year, by far the most in the world, according to the International Council of Shopping Centers. The United Kingdom had five; Spain, four; and Germany, two. Historically, urban planners in Europe carefully limited the ratio of retail space to people, whereas the U.S. took a more Darwinian approach, according to Michael Brown, a partner at consulting firm A.T. Kearney who specializes in store chains…

At the current pace of store closings, it could take 10 years to bring the U.S. near equilibrium, says J.P. Morgan analyst Matt Boss. UBS forecasts 75,000 closings by 2026, not counting food, assuming that e-commerce rises to 25% from its current 16%…

The retail reckoning will hit department stores especially hard, according to UBS. Sales there have fallen 33% since their 2005 peak, but the store count increased 23% over the decade ended in 2016. Recent closures by Bon-Ton and Sears, along with Macy’s and J.C. Penney, haven’t yet brought supply in line with demand.

UBS also sees specialty-clothing stores like Gap (GPS) and L Brands accelerating closures. In April, the bank estimated that clothing needs to shrink its store base by 17%; electronics, 22%; home furnishings, 18%; and grocery, 8%. It sees home improvement and auto parts as relatively well positioned.

(Barrons)

The US has far more retail space per person than other developed nations

Real Estate values are now financially impacted by climate change risks…

 

A good report for investors in REITs or individual real estate.

Climate Risk, Real Estate, and the Bottom Line
(FourTwentySeven)

Chart geeks will love this big visualization…

 

@trevornoren: “The world’s biggest and most notable power plants – from Fukushima to the Three Gorges Dam – with a single metric – daily megawatt hours, which represents the amount of energy any given power source generates each day”

Worlds largest and notable energy sources
(InformationIsBeautiful)


A good chart by the Freddie Mac economist showing the equity re-build by U.S. home owners…

 

Rising home prices help build equity
(Freddie Mac)

And a chart showing how many mortgages could be tapped for home equity as rates continue to move lower…

 

Mortage rates falling below 4% moves as much as 4 trillion in the moneyt for a refinance

Catch up on past Weekly Research Briefings >