Month: October 2024

Weird Things Are Happening in the Bond Market Treasuries are wobbling without the usual collateral damage.

(…) Yields on 10-year US Treasuries have risen nearly 70 basis points since the Federal Reserve’s punchy half-point initial rate cut on Sept. 17.

What’s even more unusual is that US sovereign bonds are having a wobble without instruments that are usually correlated coming along for the ride — with the exception of UK gilts, for similar fiscal worries. The US dollar has strengthened 4% over the past month, so it’s evident foreign money isn’t fleeing US assets; it’s just not being parked in the usual safe spot of Treasuries.

(…) the most startling disconnect is within the US fixed-income space – with corporate credit spreads tightening despite the exodus from the sovereign benchmark. High-yield spreads have narrowed 150 basis points in the past year – and are near record tightness. Debt capital markets are in rude health with new bond deals this year matching the volumes and variety of credit quality as in the pandemic’s banner years.

With so much in Goldilocks territory, Washington must be the problem here. The economy is broadly ticking along nicely, but importantly neither is it too hot. (…)

This isn’t really an inflation-driven scare either, as the Fed’s preferred core Price Consumption Expenditure gauge is close to its 2% target. Persistent weakness in the crude oil price would normally be helping bonds. Yields on Treasury Inflation-Protected Securities have matched about half of the increase registered by their nominal brethren, but now return 2% after inflation — close to the most generous since the global financial crisis.
What is notable in the past month is a rise in the cost of buying downside option protection — along with pressure in the repurchase markets. That indicates not only an increase in portfolio hedging but also short positions being put on. Bond-market volatility is the highest since late last year but this may shelve off sharply post Nov. 5.

Fear of the unknown is an ephemeral thing even if nothing much in the real economy has changed. Any incoming administration’s capacity to splurge fiscally will be heavily limited, not just legislatively but by bond-market appetite. Reality will hit hard if nothing can be funded. Once the event risk of the election passes, the elastic of the fundamental valuation relationship of the global bond benchmark to other asset classes could well snap back.

Some clues:

• Stronger for longer:

(Ed Yardeni)

• Deficit Threat Drives Bond Yields Higher Investors expect Trump would increase budget gap with tax cuts

The prospect of a rising federal budget deficit is fueling a sharp climb in bond yields, with investors betting a challenging fiscal situation might only get worse after the election.

Treasury yields, which rise when bond prices fall, jumped Monday after a $69 billion government auction of 2-year notes attracted tepid demand from investors. That marked the latest leg in a weekslong bond-market selloff that began after a run of strong economic data undercut bets on rate cuts from the Federal Reserve.

The auctions aren’t poised to get smaller soon. When the Treasury Department releases its quarterly borrowing plans on Wednesday, it will almost certainly maintain record-large debt sales over the next three months. There is also a chance that it could hint that further increases are coming next year, according to some analysts.

Most investors expect the budget deficit to remain elevated no matter who wins in next week’s elections, with the cost of spending programs such as Medicare and Social Security climbing faster than federal revenues. Still, many think the budget gap will expand the most if Republicans sweep control of both the White House and Congress, leading to extensions of old tax cuts and the possible addition of new ones.

That view has been evident in recent days, with longer-term Treasury yields climbing as betting markets showed former President Donald Trump’s chances of victory increasing. Trump’s campaign proposals would expand deficits by $7.5 trillion over a decade, according to a recent analysis—more than double Kamala Harris’s proposals. (…)

Deficits typically grab the attention of investors when there is a major shift in the fiscal outlook, as can often happen around an election.

TD Securities estimates that the fiscal year 2025 deficit will be around $2 trillion under any political scenario, up from $1.8 trillion in the fiscal year that just ended on Sept. 30.

The election outcome could make a bigger difference the following year, with TD estimating a $2.2 trillion deficit under a Republican sweep versus a $2.05 trillion deficit if Harris wins but faces a divided Congress, a scenario that polls suggest also has a good chance of happening. That gap can largely be explained by the expiration of 2017 tax cuts at the end of 2025, which analysts expect would be fully extended by Republicans, but only partially extended if Democrats hold some power. (…)

Bills made up 21.7% of outstanding Treasurys at the end of last month. That is a little higher than the 15%-20% range recommended by a private-sector Treasury advisory group in 2020 but still below the long-term average of about 22.4%.

In a recent report, analysts at Goldman Sachs argued that there is a chance that Treasury officials on Wednesday could signal openness to increasing coupon auction sizes next year to avoid a scenario in which the share of bills climbs too high.

But analysts at BNP Paribas struck a relatively relaxed tone on the issue. “Having more T-bill flexibility allows for steady coupon issuance,” they wrote in a recent report, adding that “T-bills are easier to absorb for markets.”

• The Federal Government debt “will soon be expanding at an annual rate of over $1.0 trillion just to cover the net interest outlays of the Treasury.” (Ed Yardeni)

• According to the Peterson Foundation, the United States spent $820 billion on national defense during fiscal year 2023, which amounted to 13% of federal spending. Defense spending in 2023 was less than the average for the last decade, which was 15% of the budget. For fiscal year 2025, the proposed defense budget of $850 billion represents about 3% of GDP vs 3.5% in 2023 and 2.9% in 2024. Procurement of weapons and systems also accounted for a smaller share of the total defense budget:

But today’s WSJ editorial might be waking many up to this reality:

(…) the world is also different than it was when Mr. Trump left office in 2021. The dictators he says he got along with then are on the march now and they’re working together more than they ever have. North Korean troops are fighting for Russia against Ukraine, and Russia is shielding North Korea from nuclear sanctions enforcement. China and Iran are also helping Russia.

The U.S. military’s advantage over adversaries has also declined, a fact that Mr. Trump has done little to acknowledge or warn about in his campaign. It will take more than flattery and unpredictability to reestablish American deterrence, and that will include Western rearmament and reliable alliances.

Here’s the CBO current projections. Realistic?

I spare you on Medicare/Medicaid and social security but the path is clear:

Deficits don’t matter, until they do.

China Industrial Profits Extend Drop as Deflation Takes Toll

Last month’s industrial profits at large Chinese companies fell 27.1% from a year earlier, after a 17.8% plunge in August, the National Bureau of Statistics said in a statement Sunday. Profits decreased 3.5% in the first nine months from the same period in 2023.

The data was “affected by factors such as high base in the same period last year” the bureau said in a statement.

Industrial profits provide a key measure of the financial health of factories, mines and utilities that can affect their investment decisions in the months to come. (…)

Deepening deflation in producer prices was likely a drag on company earnings despite faster growth in industrial output, Bloomberg Economics said before the release. Factory-gate prices extended declines for a 24th straight month in September, with the recent drop accelerating, reflecting weak domestic demand.

The country’s top legislative body will hold a highly anticipated session in Beijing on Nov. 4 to 8, as investors watch for any approval of further fiscal stimulus to revive growth. (…)

At a Pivotal Moment, U.S. Economic Data Will Be a Mess Days before the election and a Fed meeting, the employment report and other indicators will be distorted by hurricanes and a strike

Hurricanes Helene and Milton are likely to wreak havoc on economic indicators at a particularly delicate time. The employment report for October comes out Friday, four days before the election. It will bear the hurricanes’ marks, which could make it especially susceptible to being spun for political advantage in the final stretch of the presidential campaign.

The Federal Reserve’s next decision on rates comes just two days after Election Day. Hurricane effects on the data will make it harder for the Fed to decide how much—or whether—to cut interest rates to keep the economy solid and inflation headed down. (…)

The storms temporarily put people out of work and shut stores, factories and construction sites. Eventually, the economy will bounce back, but these effects make it harder to understand how things are faring now. (…)

Initial claims for unemployment insurance in Florida, Georgia, South Carolina, North Carolina and Tennessee all rose in early October in response to Helene, as did claims in Florida after Milton. 

Federal Reserve governor Christopher Waller in a mid-October speech said he expected the hurricanes and Boeing strike to reduce employment growth by more than 100,000 jobs. Based on jobless claims, damage estimates and past hurricanes, economists at Goldman Sachs calculate the hurricanes alone will cut employment growth by 40,000 to 50,000 jobs. JPMorgan Chase estimates about 50,000, while Barclays has 50,000 to 60,000.  

Wages could be distorted upward. That is because hourly workers are more likely to lose their paycheck when a storm hits than salaried workers who tend to earn more. That skews average pay higher. 

Unlike payroll job growth, which is based on a survey of employers, the storms may not have much effect on the unemployment rate, which is based on a separate survey of households. Respondents who say they had jobs but weren’t at work because of bad weather are still counted as employed. There can still be some effect on the unemployment rate, but it tends to be modest. Striking workers are also counted as employed. (…)

The weeks that follow could also be challenging. The Commerce Department’s retail sales report for October will be weighed down by hurricanes, which closed many stores and restaurants. Industrial production, construction and home sales activity will also likely take a dip.

Inflation, meanwhile, could be slightly warmer than otherwise as a result of shortages caused by the storms. In addition to halting production at some auto plants, the storms destroyed a lot of vehicles, with Moody’s estimating insured auto losses at $3 billion to $5 billion. Demand for replacement cars could arrest the downward drift in new and used vehicle prices over the past year. Car insurance rates in hurricane-hit states are also due to rise. (…)

Indeed, in GDP terms, the economy might look a bit better off than if the hurricanes hadn’t happened. People will go back to work, and lost sales will end up merely delayed instead of canceled. Meanwhile, rebuilding efforts will add to GDP and could exceed activity that was permanently lost. (…)

Volkswagen plans to close at least 3 German plants and cut thousands of jobs Europe’s largest carmaker tells works council it would slash pay by 10%

• Mercedes-Benz and Porsche look for cost cuts after China slump hits profits

EARNINGS WATCH

S&P 500 Profit Beats Disappoint as Season Kicks Into High Gear

Nearly a third of the way through the reporting season, about 75% of firms have posted profits for July to September that exceeded analysts’ expectations, according to data compiled by Bloomberg Intelligence. That’s the weakest showing since the fourth quarter of 2022 and comes even as estimates were lowered ahead of the season. (…)

This week is the busiest for company reports. Investors are awaiting results from firms accounting for nearly 42% of the S&P 500’s market capitalization, including from Microsoft Corp., Starbucks Corp. and Meta Platforms Inc. (…)

LSEG IBES numbers are somewhat different than Bloomberg’s:

181 companies in the S&P 500 Index have reported earnings for Q3 2024. Of these companies, 79.0% reported earnings above analyst expectations and 18.8% reported earnings below analyst expectations. In a typical quarter (since 1994), 67% of companies beat estimates and 20% miss estimates. Over the past four quarters, 79% of companies beat the estimates and 16% missed estimates.

In aggregate, companies are reporting earnings that are 6.1% above estimates, which compares to a long-term (since 1994) average surprise factor of 4.2% and the average surprise factor over the prior four quarters of 6.5%.

Of these companies, 59.4% reported revenue above analyst expectations and 40.6% reported revenue below analyst expectations. In a typical quarter (since 2002), 62% of companies beat estimates and 38% miss estimates. Over the past four quarters, 62% of companies beat the estimates and 39% missed estimates.

In aggregate, companies are reporting revenues that are 1.6% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.3% and the average surprise factor over the prior four quarters of 1.1%.

The estimated earnings growth rate for the S&P 500 for 24Q3 is 4.4% [it was +5.0% on Oct. 4]. If the energy sector is excluded, the growth rate improves to 7.0% [7.1%].

The estimated revenue growth rate for the S&P 500 for 24Q3 is 4.4% [4.0%]. If the energy sector is excluded, the growth rate improves to 5.3% [4.8%].

The estimated earnings growth rate for the S&P 500 for 24Q4 is 11.2% [12.5%]. If the energy sector is excluded, the growth rate improves to 13.7% [14.8%].

Energy, Industrials and Health Care are coming in much weaker than expected. Financials are much better. Tech and Comm Services are in line.

• As S&P Rally Broadens Beyond Tech, Profit Growth Remains Elusive Once struggling stock sectors jump despite muted results

The seemingly unstoppable US stock market continues to rise despite Big Tech’s slump, as the gains diversify to industry groups like real estate that struggled through the first half of the year.

The same, however, cannot be said for corporate profits. And that raises a question about how long the breadth of the rally can stay strong.

“The rally might be broadening out in terms of the action in the stocks,” said Matt Maley, chief market strategist at Miller Tabak + Co. “But it’s not broadening out in the overall earnings picture.”

Earnings for companies in the S&P 500 Index are expected to climb 4.3% from a year ago. But strip out the so-called Magnificent Seven mega tech companies — Alphabet Inc., Amazon.com Inc., Apple Inc., Meta Platforms Inc., Microsoft Corp., Nvidia Corp. and Tesla Inc. — and the anticipated profit expansion nearly disappears, according to data compiled by Bloomberg Intelligence. Take out tech and communications more broadly, and the growth turns negative. (…)

In the third quarter, the Bloomberg Magnificent 7 Index trailed the equal-weight version of S&P, in which the weighting of each stock is the same regardless of the company’s market capitalization, for the first time since 2022. Within the S&P 500, utilities, real estate and financials have been the dominant sectors since the start of July, while information technology and communications services are barely in the green. (…)

Wall Street analysts anticipate the Magnificent Seven’s third-quarter profits will be up more than 18% from a year ago. That’s a sizable drop from 37% year-on-year growth in the second quarter but still leading the S&P 500, where the remainder of the index is expected to be about flat. Indeed, without the tech and telecom sectors, S&P 500 companies are projected to post a decline in earnings growth, according to data compiled by Bloomberg Intelligence. (…)

Indeed, information technology and communications services are the only S&P 500 sectors expected to deliver double-digit earnings-per-share growth in the third quarter. The index as a whole is projected post 4.3% EPS growth, data from Bloomberg Intelligence shows. Of the S&P 500’s anticipated EPS of $60.26 in the third quarter, more than half is seen coming from the info tech sector.

It’s the same with revenues. In this case, information technology is the lone sector with an anticipated double-digit rise in the third quarter, according to Bloomberg Intelligence data. The S&P 500’s revenue growth is seen at 5.1%, and without technology it’s expected to be 4.4%, according to data compiled by BI. (…)

It was Bloomberg itself that ran S&P 500 Is Surviving Big Tech’s Slide as ‘Other 493’ Catch Up on September 15, seeking to justify tech’s underperformance since July 16.

“Investors love to look at companies that are going from earnings declines to earnings gains,” Michael Casper, an equity strategist at Bloomberg Intelligence, said in an interview. “That’s kind of leading them away from tech and to the other 493 stocks that were cast aside.”

The problem was, as I warned on September 16, and again in October 7, that the so called broadening of earnings would only really start in Q4 if analysts proved right as only 3 sectors were expected to report above average earnings growth in Q3 per LSEG’s tally, and only one outside tech. In fact, IT and Communication Services companies, which contributed 37% of the S&P 500 earnings growth in Q2, were forecast to contribute 74% of the growth in Q3.

The most recent estimates narrowed that broadening from 7 to 5 sectors in Q4, 4 in Q1’25 and 5 in each of the following quarters. IT and Communication Services are seen rising their earnings 19.1% in 2025 to account for 34.4% of S&P 500 earnings, up from 33.1% in 2024.

In terms of revenues, Q2’25 looks like broadly strong, but not for long:

For all of 2025, only 5 sectors are expected to beat the S&P 500 earnings growth rate:

If there is but one observation from the above, it’s the expected consistency in IT/Tech earnings outperformance.

We need to keep in mind that 5 of the S&P 500 eleven sectors are primarily goods-sensitive in an economy primarily services-sensitive. The Consumer Discretionary and Staples sectors include distributors (services) which sell goods that are largely imported. The U.S. industrial base remains weak, reflective of the ongoing “goods-recession” as illustrated by

     1- S&P Global’s PMI manufacturing surveys over the past 24 months:

     2- and by the Conference Board’s goods-biased LEI:

A true, sustainable “broadening” will only occur when the two above indicators turn clearly positive. Much lower interest rates are needed for this revival which also needs housing to participate.

“The Federal Reserve’s recent actions are a good start, but it will likely take more time, more rate relief, and looser lending conditions before we start to see the flow-through effect in the construction, industrial, and consumer durables market that are so impactful to steel demand.” – Nucor CEO Leon Topalian

The earnings facts are that trailing 12-m EPS are now $234.47, up 7.2% YoY and forward EPS are $265.03, +11.1% YoY.

Full year EPS are seen reaching $242.33 in 2024 ($241.28 on Oct. 4) and $275.44 in 2025 ($276.45 on Oct. 4).

Japan’s Stability Gets a Monster October Surprise Weakened leader Ishiba may struggle to form a majority outside the LDP’s usual comfort zone.

Other countries have elections too. And sometimes, voters make decisions that politicians and markets didn’t expect. Exhibit A for this is Japan, where the Liberal Democratic Party has just been deprived of a governing majority for the first time since 2009. It doesn’t matter as much to the rest of the world as next week’s US election probably will, but there will be consequences. (…)

Shigeru Ishiba took over as prime minister at the beginning of this month, following the resignation of Fumio Kishida, and called the vote to strengthen his position. It has done the opposite. Gearoid Reidy explains elsewhere in Opinion just how badly Ishiba, one of Japan’s most experienced and respected politicians, has bungled his first month in charge of Japan’s hegemonic party that has governed with only two interruptions since 1955. (…)

The yen remains important to the global system, and Japan’s descent into uncertainty might even prompt a return for the carry trade — borrowing in countries with low interest rates, such as the yen, and parking elsewhere to pocket the profit. The currency has now given up all its gains since the Bank of Japan hiked rates in late July. (…)

Now, the initial reaction is that the political mess will make it harder for the Bank of Japan to be restrictive, even though part of the LDP’s problem was dissatisfaction with rising prices, which a generation of Japanese hasn’t known. That might provide more easy money for the rest of the world. The initial reaction in Tokyo suggests that the weak yen is as ever strengthening Japanese stocks. But the convulsions of early August as the carry trade unwound is a reminder than an unstable Japan is not good news for anyone.

Oil Is Calm

Another big event since markets last traded: Israel’s missile attacks on Iran. It wasn’t unexpected, but the reaction of the oil market in Asian trading has been a little counterintuitive. Crude prices dropped more than 5%. Israel opted not to attack the oil industry directly, a possibility once widely canvassed, and Iran swiftly confirmed that its production was unaffected. (…)

Despite initial appearances, the short-term move downward makes sense. Not only was oil production unaffected, but both sides seem to lack appetite for another round of escalation. (…)