Great article from the WSJ. WMT is so big, its corporate decisions impact the whole economy.
Wal-Mart Shrinks the Big Box, Vexing Vendors Wal-Mart is paring the number of products in its stores, aiming to better organize an unruly system for managing inventory while keeping shelves neat and better stocked. But the efforts have added to tensions with vendors.
(…) At the U.S. chief’s direction, the retail behemoth has already removed about 15% of store displays over the past year, and the average Wal-Mart supercenter—home to around 120,000 products—has about 2,500 fewer items than a year ago. (…)
“It’s the objective of every retailer to grow their inventory slower than sales,” said Mr. Foran. “We just carry too much inventory. And we carry too much inventory across most parts of the box. And so we do have lots of work under way to get that sorted.”
(…) news of next year’s lower profits sent shudders through the supplier community, where there are concerns that there will be “increased pressure on suppliers to fund their problems,” said one Arkansas-based executive at a large consumer-goods company. (…)
“Wal-Mart’s ‘same-store sales’ is the single most important number to big consumer-products companies,” because it helps predict their own financial health, says Barry Calpino, a former vice president at Kraft Foods Group Inc. who is a consultant to large food companies. “They want Wal-Mart to do well,” he says. (…)
In some cases Wal-Mart is asking suppliers to offer lower prices on goods made in China to reflect a weaker yuan, according to a person familiar with the negotiations. (…)
We had the dollar, slow exports, weak oil biz, and a slower China. Add the WMT repo, trimming inventory and “asking” suppliers to contribute.
See a trend in these recent news?
- Oct. 20: Fedex approved a contract for pilots with a 10% signing bonus and 3% pay increases for 6 years.
- Oct. 21: NetJets to hike pilot pay 30% over 5 years.
- Oct. 22: New contract boosts entry level workers pay from $17.50 to $29.00 over 8 years.
- Oct. 22: ADP said that average hourly wages for same job employees rose 3.5% in Q3, from +2.5% in Q2 and +1.9% in Q1.
- Oct. 23: Pulte said it is paying more to attract and retain labor.
- Oct 26: United Air reaches tentative deal with wage hike for maintenance workers United Airlines said on Friday it reached a tentative deal with the union representing its maintenance workers, paving the way for a wage hike and the first contract to cover technicians from both United and Continental since the airlines merged in 2010. The deal provides for a 25 percent raise for United’s highest-earning technicians, to $46.15 per hour, according to an email the company sent employees and seen by Reuters. It also includes an offer for a $100,000 buyout for at least some workers and furlough protection.
- Oct. 26: GM, UAW Reach Tentative Deal The United Auto Workers has struck a tentative labor deal with GM, avoiding a strike that would have dented the company’s U.S. production. (…) the deal presents “significant” wage gains and job commitments, and provides a road map for entry-level workers to grow into the more senior hourly wage. (…)
More info from Reuters:
The Fiat Chrysler deal set an eight-year path from hiring to top pay, which goes from $17 per hour to nearly $30 per hour. Fiat Chrysler workers hired after 2007 won a ratification bonus of $3,000, and those hired before 2007 got $4,000 bonuses.
GM has fewer so-called “second-tier” workers in a two-tier pay structure created in 2007. GM has about 20 percent second-tier workers, compared with 45 percent at Fiat Chrysler and 28 percent at Ford.
GM’s labor costs going into this year’s talks were higher than Fiat Chrysler’s, the Center for Automotive Research said. It put GM U.S. labor costs at $55 per hour, compared with $47 per hour at Fiat Chrysler.
Ford has per-hour U.S. labor costs of $57, the Center for Automotive Research says.
China Pessimism Is Overblown, IMF says, Citing Booming Services Sector Recent Chinese economic data is stoking fear the world’s second largest economy is decelerating at pace that could pull the global economy into a recession. But the IMF’s top Asia economist says such pessimism may be unwarranted.
(…) Old ways of measuring China’s economy—such as looking at electricity consumption—are outdated because they don’t accurately reflect the changing nature of growth, Mr. Rhee said. Services now account for more than 50% of the country’s economy and there is a good chance their contributions are being underestimated, he said.
On first glance, China’s trade data appears to support worries about the economy. But digging a little deeper into the numbers may actually show the country’s move towards a growth model more reliant on consumer demand is already bearing fruit.
Although the value of imports has fallen, volumes tell a different story. By adjusting for the fall in commodity prices and the appreciation in the yuan, the IMF calculates imports actually grew in July by 2%. And while the amount of goods imported has declined, imports of services are in double digits.
China’s real-estate sector has also fomented concerns. But Mr. Rhee said there are signs property prices are stabilizing.
That is not to say the IMF believes there is no cause for apprehension.
(…) The IMF estimates overinvestment totals nearly 25% of the country’s growth domestic product. That means government-owned firms will struggle to pay their loans on mountains of credit.
“If they mismanage the financial market, then they could have a hard landing,” Mr. Rhee said.
Beijing is facing a daunting task. Winding down the amount of credit in the system too quickly could stall growth. But failure to cut corporate debt levels and deal with bad loans quickly could create a bigger credit crisis over the next couple of years.
“One question is whether China can manage this transition with the current governance system,” the senior IMF official said. “That is a critical issue.”
(…) That’s why, even though the IMF is backing more stimulus by Beijing to prevent too much deceleration in the economy, fund officials are concerned the government may depend too much on the old system of juicing the economy through credit. Counting on monetary policy, rather than using the budget to stimulate the economy, could exacerbate the problem of overcapacity. (…)
The IMF wants Beijing to instead to use tax cuts or more state benefits for the poor to drive more consumption.
With a modest amount of stimulus, Mr. Rhee said the IMF is confident the economy will slow to around 6.5% in the second half of this year, putting the growth rate on target to hit its 6.8% forecast for the year.
Still, even if China’s growth doesn’t fall off a cliff and slows to an IMF-expected rate of 6.3% next year, the effects on the global economy are much larger than the fund originally predicted.
“The spillovers that we are now seeing are much larger than we anticipated…about double what we thought it was” Mr. Rhee said. That means that for every one percentage-point cut in China’s growth, it saps around 0.8 percentage point of growth from many Asian economies, he said. (…)
China will be able to keep economic growth at around 6-7 percent annually over the next three to five years, a top People’s Bank of China policymaker said on Saturday, a day after the bank cut interest rates for the sixth time in less than a year. (…)
“China’s future economic growth will still be relatively quick. Around seven, six-point-something – these will all be very normal,” he told a conference in Beijing. (…)
China will lower the reserve requirement ratio – the amount of cash that major banks need to keep on hand – in the future at a “normal” pace, Yi said.
The vice governor said the PBOC planned to keep interest rates at a reasonable level to reduce the corporate debt burden, and noted that interest rate liberalization does not mean that the central bank would reduce regulation of rates.
China will also continue to set benchmark lending and deposit rates for some time, he said, but these rates would not restrict market pricing. (…)
Yi also commented on China’s debt levels. He said that China did not have exceptionally high debt levels, and while the bank is not overly anxious about cutting the level of leverage in the economy, the overall strategy is to stabilize leverage levels.
Chinese premier Li Keqiang has said his government will not “defend to the death” its goal of 7 per cent economic growth this year — a day after Beijing cut interest rates for the sixth time in 12 months. (…)
“We have never said that we should defend to the death any goal, but that the economy should operate within a reasonable range,” Mr Li was quoted as saying in a speech to the Central Party School that trains officials in the ruling Communist party. (…)
Today the Peoples Bank of China cut the benchmark interest rate by .25% and lowered banks’ reserve requirements by .5%. The measure is supposed to spur growth and make life a little easier on debt-ridden Chinese companies. In the immediate term it may give a slight boost to the economy, but there is no chance this measure, or others like it, will keep the Chinese economy from slowing much further in the years ahead. Let us explain.
The continued and dramatic slowing of the Chinese economy in the years ahead is baked in the cake. For the last decade Chinese growth has been fueled by investment in infrastructure (AKA fixed capital formation). In an effort to sustain a high level of growth massive and unprecedented investment in fixed capital was carried out and fixed investment has now become close to 50% of the Chinese economy. On the flip side, consumption as a percent of GDP has shrunk from about 46% of GDP to only 38% of GDP. Most emerging market countries run with fixed investment of around 30-35% of GDP and with consumption accounting for about 40-50% of GDP – exactly the opposite dynamic of the Chinese economy. China has run into a ceiling in terms of the percent of the economy accounted for by fixed investment and now fixed investment must shrink to levels more appropriate for China’s stage of economic development. This necessarily implies a slowing of the Chinese economy from what the government says is near 7% to something closer to 2-4%, and that is in the optimistic scenario in which consumption growth picks up the pace to mitigate the slowdown in investment.
This is why cuts in rates mean practically nothing for China’s long-term economic prospects. In the short-term rate cuts may postpone corporate bankruptcies by allowing companies to refinance debt at lower rates. Rate cuts may also make housing more affordable, on the margin. But these are cyclical boosts that act as tailwinds to China’s economic train. No amount of wind, save a hurricane, is going to keep the train from slowing.
Canada’s annual inflation rate dipped to 1.0 per cent in September on lower prices for gasoline, marking the 10th straight month it has been below the Bank of Canada’s 2.0 per cent target, Statistics Canada said on Friday.
Gasoline prices fell by 18.8 per cent in the 12 months to September compared with a 12.6 per cent decrease in August. The drop overwhelmed the rest of the index, even though seven out eight components posted an increase from September 2014.
Core inflation, which strips out volatile items and is closely watched by the Bank of Canada, advanced by 2.1 per cent, the same as in August. (…)
Cash Crunch Clouds Future for Big Oil Firms The world’s biggest oil companies are struggling to generate enough cash to cover their spending and dividends.
Spending on new projects, share buybacks and dividends at four of the biggest oil companies known as the supermajors— Royal Dutch Shell PLC, BP PLC, Exxon MobilCorp. and Chevron Corp.—outstripped cash flow by more than a combined $20 billion in the first half of 2015, according to a Wall Street Journal analysis. (…)
the supermajors have slashed spending by more than $30 billion in recent months, laying off workers and delaying projects. More cuts are expected. (…)
Last month, credit-rating firm Moody’s Corp. said it expected the cash-flow crunch to continue well into 2016. The world’s integrated oil companies—which explore for crude, pump it, refine it and sell it to consumers—will have a cash-flow deficit of as much as $80 billion this year and $55 billion next year at current price levels, Moody’s said. (…)
In response to questions, the four companies pointed to efforts to boost cash flow and manage spending to support their dividend payments. Chevron has said it would be able to cover its dividends and capital expenditure from cash flow by 2017 and recent analysis by Bernstein Research said Shell could do the same by 2018 even if prices remain at $50 a barrel.
Exxon said its capital spending peaked in 2013 and its free cash flow more than doubled in 2014 compared with the previous year. Among the supermajors, Exxon is the only one to have maintained a sizable—if reduced—share-buyback program this year, in addition to cash dividend payments. The Irving, Texas company has said it is committed to a reliable and growing dividend.
The companies have said they still expect their production to increase, despite the spending cuts. (…)
Danish conglomerate A.P. Møller-Maersk A/S on Friday cut its full-year profit guidance, saying global demand for container shipping—the conglomerate’s biggest contributor—has been weaker than expected. (…)
Slowing growth in China and the eurozone’s anemic economy have pushed freight rates to levels that barely cover fuel costs. They are hovering around $300 a container on the main Asia-to-Europe trade loop, well below the $1,300-a-container average that ship operators say they need to break even in the long term.
The rock bottom rates during what is supposed to be peak season for container shipping as retailers stock up on clothing, electronics, home appliances and toys ahead of the year-end holidays.
This year that gift-giving bounce hasn’t materialized and market watchers are blaming lower demand from Europe, as well as an easing Chinese appetite for luxury items and other imports. Shipping brokers in London and Singapore said the August devaluation of the yuan had a profound effect on shipments of luxury goods from Europe.
“We are seeing shipments of luxury items like handbags, branded clothing and shoes down by around 18% since the devaluation,” said one broker. (…)
“The only thing which is surprising is that the profit warning didn’t come much earlier,” said Lars Jensen, who runs Copenhagen-based SeaIntelligence Consulting. “This is going to be an industry-wide issue this year.”
U.S. Firms Warn of Slowing Economy Quarterly profits and sales from big American companies are poised to fall for the first time since the recession, as some industrial firms warn of a pullback in spending.
(…) From railroads to manufacturers to energy producers, businesses say they are facing a protracted slowdown in production, sales and employment that will spill into next year. Some of them say they are already experiencing a downturn.
“The industrial environment’s in a recession. I don’t care what anybody says,” Daniel Florness, chief financial officer of Fastenal Co., told investors and analysts earlier this month. A third of the top 100 customers for Fastenal’s nuts, bolts and other factory and construction supplies have cut their spending by more than 10% and nearly a fifth by more than 25%, Mr. Florness said.
Caterpillar Inc. last week reduced its profit forecast, citing weak demand for its heavy equipment, and 3M Co., whose products range from kitchen sponges to adhesives used in automobiles, said it would lay off 1,500 employees, or 1.7% of its total, as sales growth sagged for a wide range of wares.
The weakness is overshadowing pockets of growth in sectors such as aerospace and technology.
Industrial companies are being buffeted on multiple fronts. The slump in energy prices has gutted demand for drilling equipment and supplies. Economic expansion is slowing in China and major emerging markets such as Brazil, which U.S. companies have relied on for sales growth. And the dollar’s strength also has eroded overseas profits. (…)
Industrial companies are not created equal. This year, in particular, the dollar and the oil slump in the U.S. are clearly discriminating which type of products are impacted as these AAR charts illustrate:
Profit and revenue are falling in tandem for the first time in six years, with a third of S&P 500 companies reporting so far. (…)
Sales are on pace to fall 4%—the third straight quarterly decline. The last time sales and profits fell in the same quarter was in the third period of 2009.
At some companies, foreign-currency effects hurt results significantly. Consumer-products maker Kimberly-Clark Corp. predicted that currency swings would slash earnings by 25% this year, while Johnson & Johnson said that the dollar’s moves would reduce sales growth by almost 7 percentage points this year, even without further fluctuations. (…)
Much of the anticipated decline stems from the hard-hit energy industry, where sales are expected to drop by more than a third from a year earlier and profits are likely to plummet 65%, Thomson Reuters says, based on analysts’ estimates. Basic-materials companies face a 17% drop in profits, and industrial sales are expected to decline more than 5%.
See more on profits below.
United Technologies Corp., which makes Otis elevators and Carrier air conditioners, said it expects profits to be flat or down in three of its four operating segments next year, despite strength in its U.S. operations. Chief Financial Officer Akhil Johri told investors last week that the Otis division’s sales in China fell 19% in the third quarter as commercial construction slumped.
Other companies voiced similar concerns. “If you look at kind of the broad industrial-production index, you see industrial production sequentially coming down,” said Fredrik Eliasson, chief sales and marketing officer at railroad operator CSX Corp. (…)
U.S. manufacturing production rose in September at its slowest pace in more than two years, the Institute for Supply Management reported earlier this month. Economic activity at 11 industries tracked by the group contracted during the month, while just seven reported growth. Meantime, manufacturers told ISM that customer inventories remained high, contributing to a slowdown in new orders.
(…) low fuel prices have boosted U.S. car sales and buoyed airlines’ results, and the U.S. construction market remains robust. And, even among manufacturers, the aerospace industry is doing well. Technology giants Amazon.com Inc. and Microsoft Corp. posted strong results on Thursday, as did Google parent Alphabet Inc. (…)
Others worry that the slowdown is spreading to consumer businesses. Wal-Mart recently warned its sales this year are likely to be flat, down from projection of as much as 2% growth, and cut its earnings forecast for next year as it raises wages.
And truckload carriers have warned that they aren’t witnessing the usual uptick in retailer demand as the holiday season approaches, thanks to stubbornly high inventories, said Alex Vecchio, a transportation analyst at Morgan Stanley. “Transportation companies are typically a leading indicator, and our data is not good,” Mr. Vecchio said.
One third of the companies in but nearly half way in terms of market caps.
Per S&P, 70% beats, roughly in line with recent quarters but below the 74% Q3’14 beat rate. Q3’15 expected EPS have declined 1.8% from their Oct. 9 estimate while Q4 estimates have dropped 0.7%.
- Overall, 173 companies (34%) have reported earnings to date for the third quarter. The percentage of companies reporting EPS above the mean (77%) is well above both the 1-year (74%) average and the 5-year (72%) average.
- In aggregate, companies are reporting earnings that are 5.2% above expectations. This surprise percentage is above both the 1-year (+4.8%) average and the 5-year (+4.8%) average.
- The blended (combines actual results for companies that have reported and estimated results for companies yet to report) earnings decline for Q3 2015 is now -3.8%. If the Energy sector is excluded, the blended earnings growth rate for the S&P 500 would jump to 3.9% from -3.8%.
- In aggregate, companies are reporting sales that are 0.5% below expectations. This surprise percentage is below both the 1-year (+0.7%) average and above the 5-year (+0.7%) average. The blended revenue decline for Q3 2015 is now -3.5%. If the Energy sector is excluded, the blended revenue growth rate for the S&P 500 would jump to 2.0% from -3.5%.
Recall that at the end of September, total EPS were expected to decline 5.1% (-3.8% now) while ex-Energy EPS were seen rising 2.3% (now +3.9%). As I have noted, there were many signs then to suggest a good earnings season, including the benign negative guidance throughout Q3. This seems to be continuing into Q4 given that, at this point in time, 19 companies (73%) in the index have issued negative EPS guidance for Q4 2015 and 7 positive. At the same time last year, 29 companies had issued negative guidance (78%) and 8 positive.
Per Thomson Reuters, the current benchmark (see TIME TO GET SENTIMENTAL), Q3’15 estimates have edged up 0.8% to $29.21 while Q4 estimates are down 1.1% to $30.10. Trailing 12-month EPS are now seen reaching $118.44 after Q3 and $118.00 after Q4.
The S&P 500 Index is up 10.3% from its September 29 low close in what resembles the quick reversal of October 2014. One major difference this time is that smaller caps are not keeping pace. The Russell 2000 is up 8.3% from its low but has only retraced 80 (40%) of the 200 points (-15.5%) lost during the June-September slide while the S&P 500 Index has retraced 195 (78%) of the 195 points (-11.7%) lost.
The Rule of 20 P/E is now 19.4, a big bounce from 17.6 at the September low. The upside to “fair value” (2144) is but 3.3% while the downside back to 17.4 is 11.5%. To offset the clear negative imbalance in the risk/reward equation, one needs to see high probabilities that
- earnings will shortly accelerate meaningfully.
- inflation will decelerate from its recent 1.9% core reading and/or
- conditions will be such that equity valuations will overshoot to at least 21.3 on the Rule of 20 (2300).
The recent May high on the S&P 500 Index was at 20.8 on the Rule of 20, the highest valuation in this bull market.
This is how BofA summarizes it:
It could simply be 1998/99 all over again. After all, a “speculative blow-off” in asset prices is one logical conclusion to a world dominated by central bank liquidity, technological disruption & wealth inequality.
Back then, as could be the case today, a bull market & a US-led economic recovery was rudely interrupted by a crisis in Emerging Markets. The crisis threatened to hurt Main Street via Wall Street (the Nasdaq fell 33% between July-Oct 1998, when LTCM went under). Policy makers panicked and monetary policy was eased (with hindsight unnecessarily). Fresh liquidity combined with apocalyptic investor sentiment very quickly morphed into a violent but narrow equity bull market/bubble in 1998/99, one which ultimately took valuations & interest rates sharply higher to levels that eventually caused a “pop”.
The 1998-2015 analogy, for what it’s worth, is working for the Nasdaq, which is currently bouncing hard, and leading the rally, after an 18% plunge. (Although it is not yet working for biotech which is consolidating after a 35% crash). (…)
BofA’s conclusion, and why new all time highs are problematic here:
As explained above, new highs thus require:
- The Fed to hike, without…
- The dollar rallying significantly because…
- European/Japanese/Chinese domestic demand surprise on the upside.
That’s a tough ask.
Betting the Fed Sits Tight Global economic woes complicate U.S. central bank’s deliberations as it meets this week; more investors are positioning for no increase this year
In the past week, China posted its softest gross-domestic-product growth since the financial crisis, Japan reported a sharp decline in export growth and European forecasters cut their projections for eurozone inflation.
The developments, together with mixed U.S. economic data in recent months, increase the likelihood the Fed will keep interest rates near zero for the rest of 2015, according to analysts and traders. The slowdown and expansive central-bank policy overseas are likely to keep U.S. long-term interest rates down while at least initially fueling purchases of riskier assets such as stocks, corporate bonds and commodities, they said. (…)
Even if investors are wrong, their positioning means the Fed runs the risk of a bad reaction if it moves ahead, say money managers and traders. (…)
(…) today’s data was current as of Tuesday, October 20. To analyze the data, we like to look at the net positioning of Asset Manager and Leveraged Fund (typically hedge funds) categories. We take total longs for each category, subtract total shorts, then divide the net figure by the outstanding number of contracts (open interest). This gives us an idea of how offside investors may be, while scaling for the size of the market. If the last few weeks in the stock market have felt like a massive chase, you’re not alone. The CFTC data helps show why. Asset managers were their most net short the S&P 500 futures on record in the weeks following the swift crash in August. Since then, however, shorts have been forced to cover. You’ll note in the chart below that hedge funds are quite short S&P 500 futures as well, relative to their historical trend. Therefore there are two large bodies of the investment community in the process of buying back shorts they established in a panic a couple of months ago. That helps explain a large chunk of the current market rally, in our view.
A sluggish global economy, soft product prices and a stronger dollar exchange rate help to explain why the third-quarter sales of 142 non-energy companies from the S&P 500 were down by -3.0% year-to-year. This drop by non-energy company sales as measured by Bloomberg News would have been deeper had it not included a -2.3% decline by financial company revenues. The narrower -2.7% annual drop by this unfinished sample’s operating income underscores the importance of cost controls to maintaining margins. Results such as these weigh against expecting much of a pick-up by either hiring activity or capital expenditures.
Third-quarter 2015’s issuance of high yield bonds from US companies plummeted by -38.0% year-over-year largely in response to a 166 bp jump by the US average composite speculative grade bond yield from Q3-2014’s 5.53% to Q3-2015’s 7.19% and a 182 bp swelling by the accompanying high yield bond spread from 376 bp to 558 bp.
Recently, the 7.59% speculative-grade bond yield was up by 162 bp from a year earlier, while the high yield bond spread of 617 bp was wider by 182 bp. According to a model employing high yield default probabilities, a national activity index and the VIX index, the high yield bond spread should be close to 517 bp, wherein a now below-trend VIX index argues for spread compression.
However, a further climb by high yield default probabilities would adversely affect equities. In this case, the VIX index would climb well above its recent below-trend reading of 15.6.
The high yield bond spread and the VIX index now diverge in an atypical manner according to the strong 0.83 correlation between the two measures since the end of 2009. In terms of recent five-day averages, the 15.6-point VIX index is less than its 16.9 median of the prior two recoveries, while the 624 bp high yield bond spread is well above its comparable median of 418 bp. This odd discrepancy will not persist indefinitely. (Figure 1.)
The ongoing slump in high yield borrowing activity extends to leveraged loans. Third-quarter 2015’s sum of US high yield bonds plus leveraged loan drawdowns plummeted by an estimated -37% annually. In terms of a moving yearlong sum, this broad measure of high yield borrowing activity was recently down by -29% from Q4-2013’s record high. (…) Though it is most premature to predict impending doom for the current recovery, the latest dive by high yield borrowing warns that the current upturn has lost its youthful vigor and with age has become more vulnerable to adverse shocks. The longer the high yield bond spread remains well above its median of the previous two recoveries the more likely is a diminution of business borrowing that is capable of stalling overall spending.
Thus, it is especially important to keep an eye on the average EDF (expected default frequency) metric of US/Canadian non-investment-grade issuers. The recent upturn by the yearlong average of the high yield EDF metric from September 2014’s cycle low of 2.2% to a recent 3.9% helps to explain an increase in risk aversion that has driven high yield borrowing lower. The record strongly suggests that unless the high yield EDF metric trends lower, high yield borrowing will remain suppressed. (Figure 3.)
The difficulties of the high yield bond market extend beyond petroleum. Third-quarter 2015’s -30.2% year-over-year plunge by the worldwide issuance of high yield corporate bonds (to $89 billion) consisted of a -83.1% plummet by offerings from oil and gas companies ( to $3.1 billion) and a -21.5% drop by supply from other companies (to $86 billion). (…)
The US Federal Reserve is losing credibility with the biggest beneficiaries of its own stimulus policy — financial players with access to cheap credit.
Part of a brokerage report assessing the threats to financial markets noted last week that more quantitative easing could be needed in the US, even after three previous rounds of the policy.
“We see another round of QE as one of the biggest risks to equities, suggesting $4.5tn was not enough to prop up the economy,” analysts at Bank of America Merrill Lynch wrote, adding that they were downgrading prospects both for the stock market and economic growth.
“What if there is a QE 4 and the market sells off?” asks one Singapore-based hedge fund manager. “There is no ammunition left. The Fed is out of bullets.”
Wall Street, in other words, seems to be belatedly joining the cynics’ camp regarding the effectiveness of the Fed’s policies. (…)
While originally QE did help heal financial markets, today it is contributing to volatility and increasing the likelihood of stress in financial markets.
That volatility stems at least partly from the contradiction between easy money today and the reality of tighter money tomorrow. The pace of the dance between risk-on and risk-off is becoming far more frenetic as a result. A rise of 25 basis points is hardly enough to worry the real economy but it is enough to unnerve easily-spooked financial markets.
On the prospect of a rate rise in September, high-yield markets dropped almost 5 per cent and credit spreads widened 275 basis points. Stocks fell 10 per cent in the US and almost 20 per cent in emerging markets. Then the markets reversed direction and money came flooding back in. The second week in October saw the largest US high-yield inflows in eight months and the largest emerging market debt inflows in five months.
But looking beyond the short term, of particular concern is the possible combination of monetary tightening with deepening deflation, both generally and in asset prices. If easy money led to higher asset prices, in the absence of more robust economic growth and corporate earnings, surely tighter money will lead to lower asset prices. (…)
There are compounding factors as well. For example, when sentiment turns bearish, the liquidity will vanish because dealers will not be there to take the other side, thanks to the Fed in its capacity not as cheerleader for risk but as bank regulator. (…)
“With the dollar up anywhere from 10 per cent to 25 per cent, we’ve effectively experienced a Fed rate hike without actually having one,” Steve Schwarzman, founder of Blackstone, noted in his earnings call last week (as the value of Blackstone’s portfolio companies dropped in line with the worst quarterly public market performance in four years in the US). (…)
Draghi sends bond yields to new lows Prospect of more QE puts two-year debt into negative territory