Inversion Brunt Depends on What Meaning of ‘Is’ Is: Taking Stock

(Bloomberg) -- Fear mongering be damned.

“The yield curve is inverted.” So yes, an inversion remains in the 3-month/10-year yield spread, and hasn’t much recovered from the dovish grenade the FOMC tossed into the mix last Wednesday. That word is supposed to trigger panic, and yes, even the Federal Reserve’s Mary Daly herself on Tuesday afternoon said that inversions have historically predicted recessions. But for market watchers (who maybe incorrectly ascribe too much value on the stock market’s forecasting ability for the economy), the S&P 500’s recent performance (up more than 1% at one point Tuesday) shows one can’t paint it all with one brush.

And what did the internals show? The rate-sensitive (and more accurately, curve-sensitive) financials were among the best performers, likely as another part of the curve continued its recent march, though this time the spread was widening, and in the longer end. Given the cyclical nature of financials and their heavy dependence on growing economies, it’s hard to say the end is nigh. And a chorus of soothsayers is also coming out of the woodwork to assuage those still paralyzed by growth and inversion fears.

JPMorgan’s strategists Marko Kolanovic and Bram Kaplan pointed to a data set that appears to allay many of those same fears -- at least when it comes to stocks. Albeit a small sample, 1978, 1989, 1998, and 2006 all saw the 10 year yield dip below the 3 -month and stocks exhibited strong returns over the following 12 months. Decent performance then continued for up to 30 months. That’s a similar conclusion to Wolfe analysts, who called an inversion a “horrible timing tool.” These aren’t insignificant voices that join Goldman Sachs analysts with similar sentiment as indicated in Tuesday’s Taking Stock.

But What About Other Sectors?

If you think about it, some of the smarter voices had been discussing the idea of a recession months ago, though, by definition, months ago was BEFORE the FOMC decision. Not that a simple dot plot amendment is the all-curing elixir, but it should serve to calm nerves that the committee was out of touch. The the FOMC expressed caution, but it’s not all bad out there. UBS analysts in a recent note described real-time data points in the economy in March healing "across multiple dimensions."

It couldn’t come at a better time for housing, which after a series of data points Tuesday (Feb. housing starts were the lowest in 8 months) that pretty much all disappointed, and lower rates should help entice mortgage demand. KB Home’s results post-market did beat as far as earnings were concerned, but their net orders declined, with the values of those orders outpacing the former, a sign of softening prices. Shares rose, and KeyBanc analysts noted the first quarter results offered "more than hope" for investors with orders meeting seasonal trends.

Lennar’s results this morning missed on the top and bottom line, though new orders did rise 24%. JPMorgan in a note earlier this week expressed a preference to LEN over KBH, if that’s any consolation as shares in the pre-market give up some of yesterday’s sympathy gains in the post-market. Homebuilders have been among the best performers this year (S15HOME index +19% year-to-date vs SPX +12%) after an awful 2018 (-33%).

A panic-laden growth outlook would be difficult to jive with those numbers, and BofAML analysts were out Tuesday in a reversal of their prior, more defensive stance, as my colleague Elena Popina pointed out. Citing strategists led by Savita Subramanian, an improving policy backdrop in the U.S. and signs of stabilization in Europe and Asia led to a shift away from more defensive names and toward consumer discretionary stocks, a near 180 degree turn from their call late last year.

Haggard Laggards

Sectors that haven’t outperformed this year include the managed care sub-sector of health care, which is getting a boost this morning, either from bottom fishing due to depressed values or from a need to merge to survive. Either way, Centene’s deal to acquire WellCare was confirmed just minutes ago, in a deal with an enterprise value of $17.3 billion. WellCare was already trading up more than 12% in the post-market after a Bloomberg report that the two were said to have held takeover discussions, and has pared some of the additional boost shares received when the deal was confirmed.

Cowen analysts note that it’s unlikely that any competing bidder would emerge, while Citi analysts note the high overlap in some states could pose a challenge for FTC approval. The weakness in the sector has likely been compounded by the numerous headwinds that are emerging from Congress as healthcare sets up to likely be a campaign issue in 2020. The two managed care names predominantly focus on government-sponsored healthcare programs, Medicaid, Medicare and the Health Insurance Marketplace.

Sectors in Focus Today

• Athletic apparel stocks (NKE, UAA, VFC, GPS) ahead of Lulu results post market that are expected to show some fireworks with an implied 11% move around earnings. Hedge fund managers own more than 6% of shares, according to data compiled by Bloomberg
• Managed care names (MOH, HUM, UHS, THC) after the CNC/WCG deal
• Optical industry names (LITE, ACIA) after Morgan Stanley amended the ratings on the players in the segment, raising LITE to overweight, cutting ACIA to underweight, and striking a "cautious tone" on CIEN for the short term; some risks to LITE include a ban to selling to Chinese customers or Apple abandoning 3D sensing, the analysts wrote
• Shoe stocks (SKX, DSW, WWW, SHOO, DECK) after SCVL results led to a nearly 20% rally
• Airlines as Southwest lowered its forecast for 1Q capacity, citing weather and unanticipated events. Monthly figures for airlines will be announced in the coming days, when investors will be anxious to see to what extent the Boeing issues weighed

Notes From the Sell Side

Papa John’s International was upgraded to hold from sell at Stifel, which cited growing investor sentiment about a turnaround plan. The firm had been the only one with a sell rating on the restaurant chain, according to Bloomberg data, and while it raised its price target to $45 from $35, the higher target still represents the lowest view on the Street. "Investors believe the worst is behind them and are willing to accord the company a hall pass to see whether the sales plan can work," wrote analyst Chris O’Cull, who added that “we struggle to see a catalyst that would cause investors to sell shares before the company has an opportunity to prove whether its sales plan can work." Despite that, Stifel remains concerned about low franchisee profits and declining transactions, though "in the near-term, investor optimism will likely outweigh these fundamental issues." This follows BTIG Tuesday, which cited concerns about the effectiveness and possible downside to sales from the changes in investments.

ON Semiconductor was raised to buy at Goldman Sachs, which wrote that the company had improved its position on a number of secular growth opportunities, including on datacenter and telecom chips, along with sensors for ADAS cameras and automotive-related chips. Though Goldman sees cyclical risks for the broad semiconductor group in 2019, "semi cyclical risks are reflected in the stock" for investors with medium-to-long-term time horizons, and “there is evidence that ON is improving cycle to cycle even with recent cyclical headwinds for the industry," though the company isn’t immune from cyclical pressures.

Tick-By-Tick to Today’s Actionable Events

• Today:
  • LEN, PAYX to post earnings before the bell
  • U.S. Senate Commerce Committee holds panel hearing on government oversight of airline safety
  • Philip Morris to participate in 2019 Credit Suisse Consumer/Retail Conference
  • AMD to hold management meeting with Buckingham Research Group
  • Kroger holds non-deal roadshow
• 8:30am -- Jan Trade Balance
• 10:00am -- Current Account Balance
• 10:00am -- Senate Committee on Banking, Housing and Urban Affairs holds hearing on mortgage finance reform, Day 2
• 11:00am -- SRE holds investor day
• 11:00am -- LEN holds earnings conference call
• 12:00pm -- BWG Strategy to hold Amazon Grocery Focused Q&A Conference Call
• LULU to report earnings after the bell
• 4:30pm -- LULU earnings conference call

--With assistance from Ryan Vlastelica.

To contact the reporter on this story: Brad Olesen in New York at bolesen3@bloomberg.net

To contact the editors responsible for this story: Courtney Dentch at cdentch1@bloomberg.net, Steven Fromm

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