SENTIMENT WATCH
August’s Hot Recession Trade Is Cooling Stocks are a hair’s breadth away from records and Treasury yields are soaring, a shift that investors say points to an unraveling of fear-driven bets that sent markets tumbling in August.
(…) Historically, when bond yields and risky assets like stocks rose together, money managers bet that growth and inflation would pick up. (…) Yet many investors doubt the moves this time around reflect an upbeat outlook. They instead believe the reversals coursing through markets now represent the walking back of pessimistic bets that roiled markets in August. After some reconciliatory gestures between the U.S. and China on trade and fresh setbacks for U.K. Prime Minister Boris Johnson ’s Brexit plan, some of the worst-case scenarios investors had feared on the geopolitical front appear to have been avoided. That has made some of the one-sided bets that took hold of the markets in August look overdone, they say. (…)
Equity funds posted one of their largest inflows of the year in the first half of September, according to Deutsche Bank, while government-bond funds posted their biggest outflows in more than five years. (…)
Hmmm…read on:
FLASH PMIs
Muted upturn in U.S. business activity growth during September
Private sector output increased in September, with the rate of expansion slightly faster than the three-and-a-half year low seen during August. The latest survey revealed modest rises in both service sector activity and manufacturing production.
At 51.0 in September, up from 50.7 in the previous month, the seasonally adjusted IHS Markit Flash U.S. Composite PMI Output Index posted slightly above the crucial 50.0 no-change value. However, the latest reading was much softer than the average seen over the past decade (55.0).
Subdued business activity growth reflected a continued soft patch for client demand during September, with some survey respondents linked to less favorable underlying economic conditions. Moreover, the rate of private sector new business growth was the weakest since the series began in October 2009.
Latest data also signalled a sharper decline in backlogs of work, thereby suggesting a lack of pressure on business capacity. Some companies responded to subdued demand conditions by cutting back on staff hiring in September. The latest survey pointed to a drop in private sector payroll numbers for the first time since January 2010. At the same time, business expectations for the next 12 months picked up only slightly from the seven-year low seen in August.
Input prices decreased for the second month running in September, which was largely driven by lower average cost burdens across the service economy. Meanwhile, prices charged by private sector firms were broadly unchanged during the latest survey period.
The seasonally adjusted IHS Markit Flash U.S. Services PMI™ Business Activity Index posted 50.9 in September, up slightly from 50.7 in August but still one of the lowest readings seen over the past three-and-a-half years.Mirroring the trend for the private sector as a whole, latest data indicated the slowest rise in new work since the survey began in October 2009. Subdued demand resulted in a faster decline in volumes of unfinished work and a reduction in employment numbers for the first time in just under ten years.
September data pointed to some relief from margin pressures as input costs dropped to the greatest extent since the survey began in late-2009, although the impact was limited by another slight reduction in average prices charged by service providers.
Adjusted for seasonal influences, the IHS Markit Flash U.S. Manufacturing Purchasing Managers’ Index™ (PMI™)1 recovered slightly to 51.0 in September, up from 50.3 in August and the highest reading since April. The latest reading signalled a modest overall improvement in manufacturing sector business conditions.
Stronger rates of output and new order growth were the main factors helped to boost the headline PMI in September, alongside a slight upturn in staffing levels. However, export order books continued to weaken, as signalled by a drop in new work from abroad for the fourth time in the past five months.
Manufacturers remained cautious in terms of their input buying strategies in September, as signalled by a further reduction in purchasing activity and lower pre-production inventory holdings. Stocks of finished goods were also depleted, which continued the downward trend seen since May.
Meanwhile, latest data pointed to only modest rises in both input costs and factory gate charges in September, although in each case the rate of inflation accelerated since the previous month.
Chris Williamson, Chief Business Economist at IHS Markit:
The survey indicates that businesses continue to struggle against the headwinds of trade worries and elevated uncertainty about the outlook. Although picking up slightly, the overall rate of growth in September remained among the weakest since 2016, commensurate with GDP rising in the third quarter at a subdued annualized rate of approximately 1.5%. Prospects also look gloomy, with inflows of new business down to the lowest since 2009 and firms’ expectations of growth over the coming year stuck at one of the most subdued levels since 2012.
Jobs are now also being cut across the surveyed companies for the first time since January 2010, as firms have become more risk averse and increasingly eager to cut costs. At current levels, the survey employment index is indicative of non-farm payroll growth falling below 100,000.
Price pressures have meanwhile also eased, with both input costs and average selling prices for goods and services dropping again in September, painting a picture of the weakest corporate inflationary pressures for a decade.
Key to the recent deterioration has been a further spill-over of the trade-led slowdown in manufacturing to the service sector. Inflows of new service sector business almost stalled in September to register the smallest rise since the survey began in 2009. A ray of light comes from manufacturing reporting some easing of headwinds, though factory conditions likewise remained among the toughest since 2009 to underscore the broad-based nature of the current lassitude.
Eurozone close to stalling in September as factory downturn deepens
The Eurozone economy came close to stalling at the end of the third quarter as demand for goods and services fell at the fastest rate in over six years. A deepening manufacturing recession, where output fell at the sharpest pace since 2012, was accompanied by a slower service sector expansion. Jobs growth and price pressures meanwhile waned and sentiment about the outlook remained among the lowest for seven years.
The IHS Markit Eurozone Composite PMI® fell to 50.4 in September according to the ‘flash’ estimate, down from 51.9 in August to signal the weakest expansion of output across manufacturing and services since June 2013. The slowdown was driven by new orders for goods and services falling for the first time since January, dropping at the sharpest rate since June 2013.
Backlogs of work fell for the ninth time in the past ten months as, facing a dearth of new orders, companies occupied their workforces by working through previously placed orders. The resulting drop in backlogs of orders was the largest since November 2014 and points to the increasing development of spare capacity.
The deteriorating current business situation was matched by ongoing gloom about the outlook. IHS Markit Eurozone PMI and GDP Expectations for the year ahead remained stuck at one of the lowest levels since 2012, lifting only marginally higher since August. The survey saw ongoing concerns about trade wars and geopolitical stress, notably Brexit, exacerbating worries about gloomier economic growth and demand prospects, both locally and globally.
With new orders falling and expectations mired close to seven-year lows, September saw an increased reticence to hire new staff. Employment rose at the slowest rate since January 2015, the rate of job creation easing for a third month running.
Price pressures also eased. Average prices charged for goods and services barely rose, registering the smallest increase since October 2016, while input cost inflation hit the lowest since August 2016.
The deteriorating picture in September was led by a deepening manufacturing downturn, where output or an eighth straight month with the rate of decline accelerating to the steepest since December 2012. Factory orders fell at the sharpest pace since July 2012, led by a further steep loss of export* sales, to hint at the production decline picking up further momentum in the fourth quarter.
Sentiment about the year ahead in manufacturing fell to the lowest since 2012, contributing to a further culling of factory jobs, which were cut to an extent not seen since April 2013. The slump in demand was met by further downward pressure on input prices, which fell at the steepest rate since April 2016, and also led to one of the largest falls in factory selling prices for three-and-a-half years.
A key development in recent months has been the broadening-out of the deterioration beyond manufacturing. With the exceptions of the weak growth seen at the turn of the year, which in part reflected protest-related disruptions in France, the expansion of the services sector in September was the smallest since December 2014.
New business inflows into the service sector also dried up to the second-lowest since 2014, and expectations of future growth remained among the gloomiest since 2013. The monthly increase in jobs was meanwhile the second-smallest since December 2016.
By country, Germany saw output fall for the first time since April 2013, the rate of decline hitting the steepest since October 2012. Services growth slipped to the weakest so far this year, while manufacturing suffered the second-largest drop in output since June 2009. Other indices hint at further weakness ahead: composite new orders fell at the sharpest rate for seven years, and jobs growth more or less stalled to show the smallest gain in six years.
Growth of both output and new orders meanwhile slowed to four-month lows in France, led by a renewed deterioration in exports. Service sector growth deteriorated to the weakest since May, while manufacturing output fell for the eighth time in the past 12 months, though the decline was only marginal.
The rest of the euro area also saw growth soften, hitting the lowest since November 2013. Manufacturers suffered the steepest drop in output since May 2013, down for a fourth successive month, while service sector activity growth eased to a four-month low.
Chris Williamson, Chief Business Economist at IHS Markit:
(… ) The survey data indicate that GDP looks set to rise by just 0.1% in the third quarter, with momentum weakening as the quarter closed. The goods-producing sector is going from bad to worse, suffering its steepest downturn since 2012, but a further worrying trend is the broadening-out of the malaise to the service sector, where the rate of growth has now slowed to one of the weakest since 2014.
The details of the survey suggest the risks are tilted towards the economy contracting in coming months. Most vividly, new orders for goods and services are already falling at the fastest rate since mid-2013, suggesting firms will increasingly look to reduce output unless demand revives. (…) A worsening labour market adds to the risk that households could trim their spending. (…)
In Germany, where the Service sector had so far kept the economy afloat:
The German economy contracted in September, latest flash PMI data showed, as the downturn in manufacturing deepened and service sector growth lost momentum. (…) The IHS Markit Flash Germany Composite Output Index registered 49.1 in September, down from 51.7 in August and its first reading below the 50 ‘no change’ threshold since April 2013. The rate of decline signalled was the steepest in almost seven years.
September’s IHS Markit Flash Germany Manufacturing PMI read 41.4, signalling the sharpest decline in business conditions across the goods-producing sector since the depths of the global financial crisis in mid-2009.
The survey showed a sustained decline in underlying demand, with total inflows of new business falling for the third month running and at the quickest rate for seven years. Slumping manufacturing orders led the decline, recording the steepest drop in more than a decade in September, though notably there was also a drop in service sector new business – the first recorded since December 2014. (…)
The automotive sector was once again highlighted as a particular source of weakness. Lower demand from abroad also remained a key factor, with both manufacturers and service providers reporting notable decreases in new export orders during the month. (…) The reduction [in backlogs] in September was again broad-based by sector and one of the sharpest recorded over the past seven years.
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South Korea’s exports have crashed to their 2009 level:
China Scraps U.S. Farm Tour, Stoking Pessimism on Trade Deal
A Chinese trade delegation canceled a planned visit to farms in the U.S. heartland, driving down stock indexes as investors turned pessimistic on progress toward resolving the two nations’ trade war.
The cancellation came only about an hour after President Donald Trump said he wasn’t interested in “a partial deal” with China based on Beijing increasing its purchases of U.S. agricultural products. U.S. and Chinese officials held negotiations this week and are aiming for a high-level meeting around Oct. 10. (…)
[Trump] said he wouldn’t relent without reaching a “complete deal” with China. Trump said that while he has an “amazing” relationship with Chinese President Xi Jinping, right now they’re having “a little spat.”
“I think the voters understand that,” the president added. “I don’t think it has any impact on the election.” (…)
U.S. and Chinese negotiators held “productive” talks on Thursday and Friday in Washington, the U.S. Trade Representative’s office said in a statement. The U.S. is looking forward to hosting “principal-level” negotiations in October, according to the statement.
China’s Ministry of Commerce called the meetings “constructive,” and said both sides agreed to continue communication on relevant issues, according to a statement on Saturday.
Top White House economic adviser Larry Kudlow said recent developments have created a “positive atmosphere” surrounding the standoff, which has been fueled by accusations of bad faith from both sides. (…)
Reuters adds this:
The Chinese delegation did not present any new proposals on core structural issues including intellectual property protections, forced technology transfers, industrial subsidies and other trade barriers, said a person briefed on the talks.
“The conclusion from the U.S. side was that we’re not close to an agreement,” the person said.
This source and another person familiar with the talks said that the Chinese delegation’s leader, Vice Finance Minister Liao Min, laid out China’s demands that any deal must remove all U.S. tariffs and be balanced so that it is not all concessions from Beijing and none from Washington.
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At 10,000 and Counting, This Company Is Flooding the U.S. With Tariff Appeals A Minnesota auto parts seller has ‘put everything else on the back burner’ to seek relief from import duties whose costs are squeezing American businesses
U.S. companies have filed more than 16,000 requests for exemptions from the $200 billion tranche of tariffs on Chinese goods that the Trump administration imposed one year ago. Of those appeals, over 10,000 have come from just one company: Arrowhead Engineered Products Inc. of Blaine, Minn.
Arrowhead imports thousands of aftermarket repair parts for cars, lawn mowers, all-terrain vehicles and other items from China, which are now all being taxed with a 25% tariff that is set to jump to 30% on Oct. 15. (…)
The Office of the U.S. Trade Representative has said it would evaluate appeals individually, weighing factors such as whether a product is only available from China and whether duties would harm the company significantly.
Trade experts said navigating the process is especially tough on smaller companies with limited resources. (…)
Lawyers and consultants that some companies have hired to manage the complexities of the process said their clients are overwhelmed. (…)
China Boosts Government Presence at Alibaba, Private Giants
The government of one of China’s top technology hubs is dispatching officials to 100 local corporations including e-commerce giant Alibaba Group Holding Ltd., the latest effort to exert greater influence over the country’s massive private sector. (…)
The Hangzhou government said the initiative was aimed at smoothing work flow between officials and China’s high-tech companies and manufacturers. But the move could be perceived also as an effort to keep tabs on a non state-owned sector that’s gaining clout as a prime driver of the world’s No. 2 economy. Representatives of the country’s public security system are already embedded within China’s largest internet companies, responsible for crime prevention and stamping out false rumors.
Government agencies may also be heightening their monitoring of the vast private sector at a time China’s economy is decelerating — raising the prospect of destabiliziing job cuts as enterprises try to protect bottom lines. (…)
“We understand this initiative from the Hangzhou city government aims to foster a better business environment in support of Hangzhou-based enterprises. The government representative will function as a bridge to the private sector, and will not interfere with the company’s operations,” Alibaba said in a text statement. (…)
Time to Worry About Corporate Debt Again It didn’t look so bad because profits were high, but then the profit figures were revised lower
U.S. financial account figures from the Federal Reserve released Friday showed the amount of money U.S. companies have borrowed continues to swell. Domestic nonfinancial companies had $9.95 trillion in debt outstanding in the second quarter, an increase of $1.2 trillion from just two years ago. At 47% of gross domestic product, the level of corporate debt in relation to the economy has never been so high. (…)
After incorporating new and revised corporate tax-return data from the Internal Revenue Service, domestic nonfinancial companies’ net operating surplus—an income measure comparable to earnings before interest, taxes, depreciation and amortization, or Ebitda—was about a tenth lower in the first quarter than previously reported.
As a result, corporate debt-to-income levels look significantly more elevated than they were before the revisions. Adjusting for earnings cyclicality and companies’ cash holdings, JPMorgan Chase economist Jesse Edgerton calculates that nonfinancial corporate debt came to 2.24 times Ebitda in the second quarter. That is a bit above the level reached in advance of the last recession, and approaching the levels reached before the previous two downturns. (…)
Source: The Daily Feather (via The Daily Shot)
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Claudio Borio, BIS Head of the Monetary and Economic Department:
(…) the credit standing of non-financial corporations in general, and the surge in leveraged loans in particular, represent a clear vulnerability. On the back of aggressive risk-taking and a search for yield, a growing portion of these bank loans to highly indebted firms have become the raw material for structured securitisations, known as collateralised loan obligations (CLOs). There are close parallels with the infamous collateralised debt obligations (CDOs), which resecuritised largely subprime mortgage-backed securities and played a central role during the GFC. (…) while the picture offers less cause for concern, financial distress cannot be entirely ruled out, especially in the light of the concentration of some known bank exposures, uncertainties about the size and distribution of indirect ones, and the surge in market finance post-crisis. Moreover, losses on these asset classes, and leveraged loans more generally, are likely to amplify any economic slowdown.
(…) Long-term U.S. federal debt projections have increased in recent years, despite the economy benefiting from a record long economic expansion. U.S. general government debt is already the highest among ‘AAA’-rated sovereigns, and Fitch’s debt sustainability analysis indicates that it could exceed 120% of GDP by 2028. This estimate is based on gradual increases in borrowing costs, widening primary deficits, and average growth just below the U.S.’s 2% potential growth rate. Federal spending will be challenged by these worsening fiscal dynamics. (…)
Guggenheim Investments’ Recession Dashboard
The six indicators in our Recession Dashboard have exhibited consistent cyclical behavior that can be tracked relatively well in real time. We compare these indicators during the last five cycles that are similar in length to the current one, overlaying the current cycle. Taken together, they suggest that the expansion may be just six months away from ending.
Yield curve inversion and recession risk(…) in addition to expectations of future short-term rates, long-term rates also reflect term premia, which can thus influence the curve’s dynamics. Term premia are extra returns demanded by investors to compensate for risks associated with long-term bonds. These returns can be affected by imbalances in the supply of and demand for particular maturities, in which case they have little information about future economic prospects as such.
In fact, the recent inversion of the US Treasury curve has coincided with exceptionally subdued term premia. Term premia in the US Treasury market have been declining since the Great Financial Crisis, likely because of demand pressure from price-inelastic buyers such as central banks, pension funds and life insurers (Graph A, left-hand panel). Also, the current combination of a negative term premium and an easing monetary policy stance is unusual. During past episodes when the yield curve inverted, the monetary policy stance was tightening.
Considering such complications, it is useful to examine other indicators of recession risk. In addition to the 10y–3m term spread, the literature has identified several other measures that can signal an impending economic slowdown. For example, a low near-term forward spread, a stretched excess bond premium and elevated financial cycle measures can signal high downside risk. The right-hand panel of Graph A compares current readings for these variables with their historical distributions before past downturns (in some cases, the variables have been multiplied by –1 so that low values point to high recession risk).
The indicators we consider provide a mixed assessment of imminent downside risks to the economy. While the term premium is clearly well below typical pre-recession levels, rate expectations are currently well above. The other indicators also do not yield a clear consensus on recession risk.
Guggenheim’s Scott Minerd adds this:
A more likely channel for rate cuts to work through would be a substantial easing in financial conditions, which Fed Chair Powell acknowledged in his July press conference. Watching the reaction of financial markets in the aftermath of Fed cuts will be key in determining how effective those cuts are, and whether a recession can be pushed back. The main channel for easing financial conditions would likely have to be a stock market rally, as longer-term rates are already pricing in aggressive easing and credit spreads are already near historical tights. This sets up one of two scenarios: either stocks fail to rally in the wake of rate cuts and the economy continues to lose steam and tips over into recession, or we see a liquidity induced market rally that supports economic growth temporarily, only for the stretched market valuations to cause a more severe downturn when the rally falters and a recession eventually arrives.
EARNINGS WATCH
Earnings revisions remain downbeat, large and small:
Even while corporate preannouncements are more upbeat than during Q2:
TECHNICALS WATCH
Lowry’s Research notes that “the rise in Buying Power and drop in Selling Pressure since the Aug. 14 market low has been the fastest since the initial rally off the Dec. 24, 2018 market bottom. On balance, the expansion in Demand and contraction in Supply in place since mid-Aug. 2019 appears most consistent with the resumption of the market’s primary uptrend from Mar. 2009.” It adds that new highs in all (small, mid and large caps) Adv-Dec lines “bode well for the market”, pointing out that “breadth typically leads price”.
Lowry’s also points out that volume has improved “confirming the rising Demand indicated by the gains in Lowry’s Buying Power Index. (…) Although some short-term
indicators suggest the potential for a near-term pullback, given the signs of ongoing intermediate-term strength, any pullback should be brief and serve as another opportunity for new buying.”
From CMG Wealth Management:
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The 13/34–Week EMA Trend Chart is wobbling but rising, or rising but wobbling:
- This bond indicator crashed to sell late last week:
The biggest signal change for the week is the Zweig Bond Model (“ZBM”), which moved from a buy signal to a sell signal. The buy signal has been in place for much of the past year. (…) The signal is a pure trend-following process that looks at price as well as the yield curve. It is my favorite trend indicator for the direction of high quality bond prices and interest rates. It is suggesting to trade to shorter-term Treasury Bills vs. longer-term Treasury Bonds (or LT high grade corporate bonds). The rules are spelled out in the upper left-hand section of the following chart. Not all trades are winners, yet that is the case with a fundamental trading decision and all other rules-based systematic process such as the Zweig Bond Model. It is best to find a process you believe in so that you can stick to the process. ZBM is my go-to indicator for the direction in longer-term interest rates and Treasury bond prices. Bottom line: Sell the rallies and shorten duration exposures.
EQUITIES VS SOME FUNDAMENTALS
In 2008, 2011 and 2015, investors cared about weakening world growth trends. Not so much now (next 4 charts from Ed Yardeni)…
…although EM equity investors seem to be caring:
Gold investors also use to care about commodity prices. Not so much currently. This also happened in 2012:
Gold has been loyal to inverted TIPS however:
Is inflation really dead?
Hmmm…”transitory” they say:
The Atlanta Fed’s Inflation Dashboard displays the diverging trends between upstream and downstream inflation trends:
Core inflation gauges’ 3-month trends (green arrows) are still below 2.0% but their inner measures are pointing to rising inflation:
This measure has rolled over but keeps suggesting inflation above 2.0%
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September 2019: The New York Fed Staff UIG Measures
- The UIG “full data set” measure decreased by 0.1 percentage point from the previous month, at a currently estimated 2.5% in August.
- The “prices-only” measure remains virtually unchanged from the previous month, at a currently estimated 1.9% in August.
- The twelve-month change in the August CPI was +1.7%, a 0.1 percentage point decrease from July.
- The UIG measures continue to estimate trend CPI inflation to be approximately in the 1.9% to 2.5% range.
China, Russia, Iran ‘plan joint naval drill in international waters’
WE just can’t wait for the movie! Drama or comedy?
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WE’re a comedy:
Some WeWork Board Members Seek to Remove Adam Neumann as CEO SoftBank officials are among those expected to push for Neumann ouster
(…) The board is expected to meet as soon as this week and potentially consider a proposal for Mr. Neumann to become We’s nonexecutive chairman, some of the people said. That would allow him to stay at the company he built into one of the country’s most valuable startups, but inject fresh leadership to pursue an IPO that would bring We the cash it needs to keep up its torrid growth. (…)
Any attempted coup is a gamble: Mr. Neumann still has allies among the directors and the ability to fire the entire board thanks to shares he controls that carry extra votes. But SoftBank, which has invested more than $9 billion into the company and is represented on the board, has considerable influence too, and We needs the Japanese conglomerate to continue pumping in cash.
It couldn’t be learned how all of the We directors—there are seven including Mr. Neumann—are aligned, and the situation is fluid. (…)
SoftBank was expected to buy as much as $1 billion in stock in We’s initial public offering, a large portion of the roughly $3 billion it sought to raise from investors, people familiar with the matter said. (…)
BTW, WeWork’s IPO prospectus listed Neumann as a risk factor, noting that the company’s future success depends in large part on him continuing to serve as CEO, “which cannot be ensured or guaranteed.” (Fortune)
WeWork’s weak Wi-Fi security leaves sensitive documents exposed Documents sent on WeWork’s unsecured network included financial records, bank account credentials and a cat photo of Nicolas Cage.
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WE’re a drama:
Rosengren Warns Co-Working Spaces May Be Creating Financial Risk
(…) “Evolving market models, along with low interest rates, are creating a new type of potential financial-stability risk in commercial real estate,” Rosengren said Friday in remarks prepared for a speech in New York. “One such market model is the development of co-working spaces in many major urban office markets,” he said, without mentioning WeWork by name. (…)
“I am concerned that commercial real estate losses will be larger in the next downturn because of this growing feature of the real estate market, which could ultimately make runs and vacancies more likely due to this new leasing model,” Rosengren said.
“The fact that the shared office model relies on small-company tenants with short-term leases, combined with the potential lack of recourse for the property owner, is potentially problematic in a recession,” he said. “This also raises the issue of whether bank loans to property owners in cities with major penetration by co-working models could experience a higher incidence of default and greater loss-given-defaults than we have seen historically.”