THE YIELD CURVE
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Markets Are Confusing Correlation With Causation The meaning of an inverted curve leads financial commentary.
(…) Not everyone is in agreement that a recession is inevitable. The global economy and markets are more interconnected than ever, which means the inversion in U.S. yields may be less a referendum on America’s economic outlook than just a move in sympathy with yields in Europe and elsewhere. RBC Capital Markets Chief U.S. Economist Tom Porcelli noted in a research report Monday that “yields have decoupled from growth in a very material way,” with 10-year Treasury yields of about 2.50 percent at the end of last week wildly out of balance with nominal economic growth of about 5 percent.
The last time nominal growth was this high, which was back 2006, 10-year yields were about 4.50 percent. U.S. “yields have become more a function of global growth dynamics and indeed have become anchored to low/negative sovereign yields abroad,” Porcelli wrote. “What this means is the United States is able to finance relatively good rates of growth at artificially suppressed interest rates. So, no, we are not on recession watch because of this dynamic. We are, more than any other point this cycle, on bubble watch.” (…)
- The NYT had this last Sunday:
Campbell Harvey, a Duke University finance professor whose research first showed the predictive power of the yield curve in the mid-1980s, stressed that an inversion must last, on average, three months before it can credibly be said to be sending a clear signal. If that does occur, history shows that the economy will fall into a recession over the next nine to 18 months.
- Charles Schwab’s Liz Ann Sonders:
(…) Every recession since the mid-1960s has been preceded by an inverted yield curve, so it’s little wonder recession fears have elevated. However, in addition to there having been “false positives,” an inversion doesn’t help define either the length of runway between the inversion and the subsequent recession; or the severity of the recession (or attendant bear market). (…)
The relationship between yield curve inversions and the economy is well known. When shorter-term rates are below longer-term rates (a normal curve), banks can lend profitably as they earn the spread by borrowing at the short end and lending at the long end. But once the curve inverts, the absence of profitability leads to compressed lending; with the resultant tightening in credit conditions contributing to a recession.
What we don’t know yet is whether Friday’s inversion was a one-off situation, with the curve destined to steepen again; or the beginning of a more protracted inversion. There is hope; with liquidity still ample amid tight credit spreads. The average return on invested capital (ROIC) for U.S. companies remains above both short- and long-term rates; while lower longer-term rates are increasingly supportive of the housing part of the U.S. economy.
(…) history can give us some guideposts; but also enough grey area to make any kind of accurate forecast a difficult task. There have been myriad analyses done on the history of yield curve inversions; with the data often expressed in median or mean terms. Because of the wide dispersion in past experiences—both in duration-to-recession and stock market performance terms—I want to share details around each of the past seven inversions.
Below are a series of six charts—each one spanning from six months prior to the inversion through the entire subsequent recession. You will see that I combined the “double-dip” recessions of the early-1980s into one chart; although each of the two back-to-back recessions had a curve inversion preceding it.
- The average span between inversions and subsequent recessions has been 11 months, with a range of five months (1973) to 16 months (2006-2007).
- The average return for the S&P 500 during the spans from inversion to recession has been +2.8%, with a range of -14.6% (2000-2001) to +16.5% (2006-2007).
- By looking only at the spans between inversions and recessions, it masks much of the equity market weakness associated with the end of each of these cycles (see below).
There is more to Liz Ann’s article (here)
Meanwhile, banks are still lending…
…and loosening standards:
A Flood of U.S. Oil Exports Is Coming
(…) What started as an American phenomenon is now being felt around the world as U.S. oil exports surge to levels unthinkable only a few years ago. The flow of crude will keep growing over the next few years with huge consequences for the oil industry, global politics and even whole economies. OPEC, for example, will face challenges keeping oil prices high, while Washington has a new, and potent, diplomatic weapon.
American oil exports stepped up a gear last year, jumping more than 70 percent to just over 2 million barrels a day, according to government data. Over the past four weeks, U.S. oil exports have averaged more than 3 million barrels a day — more than what Middle East petro-state Kuwait sells. (…)
Oil traders and shale executives believe U.S. crude exports are set reach 5 million barrels a day by late 2020, up another 70 percent from current levels. If the U.S. hits that target, America will be exporting, on a gross basis, more crude than every country in OPEC except Saudi Arabia. (…)
The U.S. is already a big exporter of refined products such as gasoline and diesel. When combined with rising crude exports, the IEA forecasts American petroleum exports will reach roughly 9 million barrels a day within five years, up from just 1 million in 2012. In the process, the U.S. will become the world’s second-largest exporter of crude and refined products by 2024, overtaking Russia and nearly topping Saudi Arabia.
Until now, the surge in U.S. oil production from the Permian and other shale basins like the Bakken in North Dakota was absorbed at home, feeding refineries in the U.S. Gulf of Mexico coast. Now, U.S. refiners are finding it increasingly hard to process more of the kind of light crude pumped in the Permian as their plants were built to process denser heavy crude — the type pumped in Venezuela and the Middle East. (…)
“If the China demand pull fails to materialize, for political reasons, quality mismatch or otherwise, U.S. exports will likely have to muscle their way into the global refining system, likely via price discounts,” Diwan said. (…)
If the forecast proves correct, U.S. crude production will surpass 13 million barrels a day by December, up from 11.8 million barrels a day at the end of last year and well above the previous all-time high set in 1970. (…)
Airbus Secures $35 Billion China Deal in New Blow to Boeing
China Plans Record U.S. Pork Imports to Resolve Trade War
(…) The final volume will depend on the progress of African swine fever in China, according to one of the people. The disease, which is fatal to pigs and is proving hard to contain in China, has been devastating its hog production since it was first reported there in August. It’s already slashed the sow-breeding herd in the world’s No. 1 pork market by 15 percent. (…)
SENTIMENT WATCH
Lyft Leading Wave of Startups That Will Make Debuts With Giant Losses With its IPO expected this week, Lyft will stand as the biggest test of the public market’s appetite for money-losing companies since the dot-com era.
(…) Lyft posted last year a loss of $911 million, more than any other U.S. startup lost in the 12 months preceding its IPO, according to S&P Global Market Intelligence. Lyft’s loss, in the sixth year since the company’s founding, could soon be eclipsed by 10-year-old Uber Technologies Inc., which has been losing more than $800 million a quarter. Uber plans to go public later this year. (…)
WeWork Cos. reported a 2018 net loss of $1.9 billion on $1.8 billion of revenue. The office-space company has indicated it intends to go public but hasn’t said when. Also, many food-delivery companies that have raised billions collectively are enduring heavy losses as they fight each other for market share, investors said. (…)
Image-search company Pinterest Inc. disclosed in offering documents on Friday that it halved its annual loss to $63 million in 2018. Data-analytics company Palantir Technologies Inc. has said it is expecting profitability in the next year or two. (…)
Of the five companies with the largest losses before an IPO, four of them—discount marketplace Groupon Inc., biotech Moderna Inc., social-media company Snap Inc. and communications company Vonage Holdings Corp. —have performed poorly on the public markets. A fifth, Viasystems Group Inc., went private years ago at a fraction of its IPO value.
For investors drawn to the coming IPOs, the main appeal is rapid growth—which Lyft has made a centerpiece of its push to Wall Street. Its revenue doubled last year to $2.2 billion in what would be the third-largest annual revenue for a U.S. startup pre-IPO, behind FacebookInc. and Google, according to S&P. Both Facebook and Google were profitable before their market debuts. (…)
Lyft spent $1.3 billion on marketing and incentives for drivers and riders in 2018, which averages out to more than $2 a ride. Many Lyft and Uber investors say they expect the incentive war will end once these companies go public because they won’t be constantly raising capital. Still, early private investors say they had hoped heavy rider subsidization would have ended years ago. (…)
Another sign of the times is the new accounting calculations as Grant’s explains:
With profitability a far-flung hope, the ride-share companies are getting creative. Lyft’s S-1 notes that the company utilizes a bespoke metric called “contribution.” Yes, contribution. Contribution is intended “to evaluate the effectiveness of our business strategies, and to communicate with our board of directors concerning our financial performance.” Unsurprisingly, the results are flattering. The contribution line-item showed a $920 million gain last year, compared to the $943 million adjusted EBITDA loss.
In a Breakingviews post Friday, columnist Richard Beales wrote of that newfound accounting innovation: “It’s a metric that’s supposed to represent a steady-state level of profitability, excluding the costs associated with growth.” But, of course, growth is what investors are paying for. The prospective valuation represents “the kind of eye-watering multiple of sales that only rapidly expanding companies attract. Switching off growth in the foreseeable future, even in return for profit, would knock that down sharply.”
“Contribution” is a new rival to WeWorks’ “community-adjusted EBITDA” which added back to EBITDA items like stock-based compensation, sales and marketing expenses, even general and administrative expenses, all mundane stuff that may have some impact on revenues and growth.
Freaking Out Over Inverted Yield Curve
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Businesses in fact reported that output growth eased to the second-lowest seen over the last year, according to the flash PMI results for March. Although the headline PMI remains encouragingly resilient, indicative of the economy growing at an annualised rate in excess of 2% (suggesting some potential upside to many current growth forecasts), signs of the business environment becoming tougher have intensified in recent months, especially in 
Growth is also likely to cool further, according to the survey’s sub-indices, and companies may soon seek to reduce capacity. Whereas new orders were growing at a faster rate than companies could boost output throughout much of last year, the surveys are now showing signs that demand is insufficient to sustain current output levels. Similarly, in manufacturing, the forward-looking new orders to inventory ratio hit a 18-month low in March and suppliers’ delivery delays (a key indicator of capacity utilisation) indicated the fewest delays for 16 months in March.
The average earnings growth momentum signalled by the indicator in the first quarter is the lowest recorded since the first quarter of 2016, a time when earnings were falling at an annual rate of 12.9%.
