May, 2018 - Edge and Odds

Special guest contribution from I. Bernobul, esq..

JP Morgan Asset Management recently published a correlation chart to which Robert Ross, the smart editor of Yield Shark and Macro Growth & Income Alert, a Mauldin Economics service, appended his own conclusion that “stock returns don’t tend to turn negative until rates hit 5%” (red square added to original chart).

The appended chart was published in the very popular Mauldin Economics’ CHARTS that MATTER and even though Ross warned that

Today, however, interest rate risk is elevated due to a US debt load that is higher than it
has ever been. And that could spell trouble for the markets even at a 3% 10-year rate.

the chart itself was highlighted as evidence that rising bond yields historically did not bother equity markets.

The chart, covering more than half a century, has a pretty convincing look.

But I instinctively and intuitively sensed something wrong with it: it just does not make any financial sense that equity values would be less rate sensitive at lower levels.

It turns out the chart, and Ross’ conclusion from it, are quite right but only because the period covered, May 1963 to March 2018, excludes years of low interest rates that actually invalidate Ross’ interpretation. Treasury yields were below 5% only 35% of the time since 1963, of which 85% occurred since 2001 with the housing bubble leading to the Great Financial Crisis and the period since 2009 when central bankers totally dominated the interest rate space.

Here’s a chart covering 1927 to 1967, forty years during which Treasury yields remained below 5%, showing 8 periods when rising Treasury yields coincided with difficult equity markets. There is no automatic relationship here and while there are periods when equities do ride along with rising yields and economic expansion, the reality is that rising yields eventually negatively impact equity values. There is no strict rule on this relationship.

As Mark Twain said, facts are stubborn, but statistics are more pliable. For facts, I suggest this post: RISING LONG-TERM RATES: THE SCARY FACTS!

Fed’s Beige Book Finds Manufacturing Shifting Into Higher Gear

(…) Most of the Fed’s regional districts reported moderate economic growth in late April and early May, the Fed said in its latest roundup of anecdotal information about regional economic conditions known as the beige book. The Dallas district was an exception, reporting a solid pickup in economic activity. The report was based on information collected through May 21.

The strength reported in the manufacturing sector arrives after the Trump administration in March announced plans to institute broad tariffs of 25% on steel and 10% on aluminum products. While some manufacturers expressed optimism in the outlook for the sector, many also noted that the new tariffs were creating uncertainty, the report showed.

In the Dallas district, manufacturing strengthened after having slowed in the previous survey period. Still, “refiners and petrochemical producers expressed negative views about the potential impact of tariffs and quotas on exports as well as new construction projects.”

Similarly, in the Minneapolis district, firms expressed that manufacturing demand was strong but indicated tariffs posed a concern to the supply chain in steel and aluminum materials markets.

Manufacturing activity expanded in the Kansas City district at a faster pace than in the previous beige book reporting period. Production, shipments and new orders grew “despite rising trade concerns,” the report said. (…)

Meanwhile, prices rose moderately in most regions, and there were several reports of rising costs for steel, aluminum, oil, lumber and cement. In some instances, retailers “were more able to pass along price increases to their customers than in the recent past.”

Employment rose at a modest to moderate rate across most districts, the report said. Many companies raised wages to address talent shortages, but wage growth overall remained modest, according to the report. (…)

Trump Is Planning to Impose EU Steel, Aluminum Tariffs The Trump administration, unable to win concessions from EU counterparts ahead of a Friday deadline, is planning to apply tariffs on European steel and aluminum, according to people familiar with the matter.
Manufacturers and consumers are hurt by this development far more than any gains we may see in steel production employment.(The Daily Shot)

No signs of de-escalation in trade dispute with U.S.: Germany’s Scholz There are no signs of a de-escalation in the trade dispute between Europe and the United States, German Finance Minister Olaf Scholz said in a Reuters interview published on Thursday, adding the EU’s response to any U.S. tariffs must be strong.
France warns of ‘trade war’ if US imposes steel tariffs
Trump set to impose steel, aluminum tariffs on Canada Ottawa has crafted a retaliation plan that would involve U.S. steel and aluminum, sources say
Trump Tariff Blow Would Go Beyond Sending BMW Sedans to $60,000

(…) Some of the top U.S. sellers of imported autos also happen to assemble a lot of vehicles at domestic factories. While about 1.2 million of the vehicles GM will sell in its home market this year will come from overseas plants, about 1.8 million will be American-made, according to LMC. And the X3 through X6 line of sport utility vehicles that BMW AG produces in South Carolina makes the German carmaker the top exporter of vehicles from the U.S. (…)

China Cuts Tariffs on Wide Range of Consumer Goods From July

The tariff cuts will apply to products including clothes, washing machines and makeup. The reduction was decided at the state council on Wednesday which was chaired by Premier Li Keqiang. (…)

The state council also decided that a negative list for foreign investment will be finished by July 1. This will specify which areas of the economy are off-limits for foreign investors, leaving all others theoretically open.

The government also vowed to protect the legitimate rights of foreign investors and clamp down on infringement and counterfeit acts, and will raise the compensation cap for intellectual property infringement. The cabinet also called for the implementation of the easing or scrapping of restrictions on foreign capital in the manufacturing of cars, ships and planes.

Bank of Canada Lays Ground for More Rate Hikes

Bank of Canada Governor Stephen Poloz left rates on hold for a third straight decision Wednesday, but gave an upbeat assessment of the economy and removed some cautious language. (…)

“Overall, developments since April further reinforce Governing Council’s view that higher interest rates will be warranted to keep inflation near target,” the central bank said. “Governing Council will take a gradual approach to policy adjustments, guided by incoming data.” (…)

The odds for an increase at the July 11 meeting are now 79 percent, according to overnight index swaps. The market anticipates two more hikes in total by the end of the year. (…)

Eurozone Inflation Jumps, but Uncertainty Still Clouds ECB Outlook The eurozone’s annual rate of inflation rose more sharply than expected in May as energy prices increased, a development that will likely reinforce the ECB’s belief that the metric will return to its target over coming years.

(…) The European Union’s statistics agency Thursday said consumer prices in the 19 countries that use the euro were 1.9% higher than in May 2017, a jump from the 1.2% rate of inflation recorded in April, the highest level since April of last year. That was a stronger rebound than the rise to 1.6% expected by economists surveyed by The Wall Street Journal last week. (…)

Excluding volatile items such as energy and food, the core rate of inflation rose to just 1.1% from 0.7% in April. (…)

Costs for necessities are also rising rapidly in the EU.

From the chart below, can you guess German bond yields today?

Uber raises US prices in boost for its drivers

Finance Chiefs Keep Borrowing, Resulting in Higher Debt Levels

(…) Roughly 4,000 non-financial firms rated by Moody’s say their leverage is about 20% higher now than in 2007. The total share of companies with an investment grade Aaa- to A-rating has fallen to 15% from 21% before the financial crisis in 2007. Baa-ratings — at the lower end of the investment-grade spectrum — have increased to 63% from 55% in 2007.

At the same time, about 60% of companies are considered speculative grade, with over 40% rated B1 or lower, according to Moody’s. Their median ratio of debt to earnings before interest, tax, depreciation and amortization is about 10% higher than in 2007, while that ratio is around 30% higher at investment grade companies than in 2007. (…)

In the U.S., speculative grade ratings represent 67% of issues and 38% of outstanding debt, higher than in other regions. (…)

Debt levels at companies have grown since 2011, according to Moody’s, rising to a median debt to ebitda-ratio of 2.6 times for investment grade rated entities and 4.9 times for speculative grade entities at the end of 2017. (…)

EMERGING SUBMERGING

Speaking of debt, this Moody’s chart shows the contributions to the aggregate EM debt-to-GDP ratio changes over the past decade. (The Daily Shot). Notice how the corporate sector contributed to the jump in debt, a significant change.

TECHNICALS WATCH

Yesterday’s demand was strong, as Up Volume was 86% of total Up/Down Volume while NY Comp. Volume matched its level on Tuesday”s sell-off. Trends in Demand were also strong given the 4 point gain in Buying Power and 5 point rise in the Short Term Index to a new rally high. At the same time, Selling Pressure fell to another new bull market low. (Lowry’s)

Back outside the wedge on the 100dma.

While the world is sitting on its (still rising) 200-day m.a.

FYI:

Mary Meeker’s 2018 internet trends report: All the slides, plus analysis
INTERESTING CHART On the United States:

Source: The NY Times, @ldaalder; Read full article via The Daily Shot)

Trump Is Planning to Impose EU Steel, Aluminum Tariffs The Trump administration, unable to win concessions from EU counterparts ahead of a Friday deadline, is planning to apply tariffs on European steel and aluminum, according to people familiar with the matter.

Trump set to impose steel, aluminum tariffs on Canada Ottawa has crafted a retaliation plan that would involve U.S. steel and aluminum, sources say

Eurozone Inflation Jumps, but Uncertainty Still Clouds ECB Outlook The eurozone’s annual rate of inflation rose more sharply than expected in May as energy prices increased, a development that will likely reinforce the ECB’s belief that the metric will return to its target over coming years.

TECHNICALS WATCH

INTERESTING CHART On the United States: