The Market’s Lost Bulls Stumble Upon a Shepherd
(Bloomberg Opinion) -- To say it’s been tough to be a bull of late in this stock market would be an understatement. The S&P 500 Index sits on the cusp of a correction, with the gauge dropping 9.88 percent from its all-time high in late September through Monday before rebounding 1.57 percent on Tuesday. Not only is the Federal Reserve not backing away from its plan to continue raising interest rates, but corporate earnings growth is poised to slow along with the economy, the trade wars aren’t going away and the midterm elections may leave the business-friendly Republican party without control of the House. Yes, things are bleak, but thank god for Gandalf.
That’s a nickname given to JPMorgan Chase & Co.’s all-world analyst Marko Kolanovic, whose timely calls have allowed him to dominate Institutional Investor’s annual rankings of top strategists for a decade or so. Stocks managed to rise on Tuesday as Kolanovic issued what amounted to a pep talk of a research note, talking up the possibility that the October “rolling bear market” turns into a “rolling squeeze higher” into the end of the year. Of the reasons cited, perhaps the most credible is the notion of a surge in corporate stock buybacks after earnings season. About $110 billion of planned buybacks will be freed up this week, more than twice last week’s $50 billion, and that total will rise to $145 billion next week, Deutsche Bank AG estimated. While it’s unlikely all the money will be spent at once, the data point to potentially improving market liquidity, according to Bloomberg News’s Lu Wang. Along with dividend payments that shareholders tend to reinvest in stocks, actual demand from corporate America will surge to $48 billion a week by mid-November from $10 billion now, UBS Group AG strategists led by Keith Parker estimated. “Buybacks have been the main driver of the equity rally in this cycle,” Deutsche Bank strategists wrote in a research note late Friday. “In the absence of outflows and further positioning cuts, which require incrementally negative news, buybacks should drive equities higher.”
More than $7 trillion has been returned to shareholders in the form of buybacks and dividends since the bull market started in March 2009, according to data compiled by S&P Dow Jones Indices. That’s equivalent to 40 percent of the value that stocks in the S&P 500 Index added during that stretch, Wang reports. In what is sure to add to the legend of Kolanovic, his call came just a few hours before IBM Corp. said Tuesday that it would buy back as much as $4 billion in shares.
THE YIELD CURVE DOESN’T (USUALLY) LIE
After a brief reversal between late August and early October, the difference between short- and long-term Treasury yields has started to shrink again. This is concerning because a flattening of the so-called yield curve has historically been associated with a slowing economy. As of Tuesday, the gap between two- and 10-year yields stood at 26 basis points, the smallest difference since Oct. 2 and down from 35 basis points a few weeks ago. That’s a signal that the bond market believes that the turmoil in stocks and signs of tamer inflation might be signaling deeper problems in the broader economy that further Fed rate hikes might expose. “While there is little risk of downturn in the near term, more restrictive monetary policy will overtake an overheating economy,” Guggenheim Partners strategists, including global chief investment officer Scott Minerd, wrote in research note to clients titled “The Yield Curve Doesn’t Lie.” “Despite prevailing sentiment to the contrary,” the note said, “the flattening yield curve remains a powerful indicator of coming recession.” The strategists note that many feel the yield curve has been unusually flat in recent years because of the Fed’s bond purchases, but they say that argument has flaws. Specifically, it fails to recognize that net Treasury issuance, post-crisis regulatory changes and foreign-exchange reserve intervention have acted in the opposite direction — steepening the curve, according to Bloomberg News’s Cormac Mullen. Not to mention that the Fed has been unwinding its balance sheet assets this year, which should have caused the curve to steepen rather than shrink from 79 basis points this time in 2017.
WILL HE OR WON’T HE?
U.S. stocks dived late Monday afternoon after Bloomberg News reported that the Trump administration is preparing to announce by early December tariffs on all remaining Chinese imports if a Group of 20 meeting between Donald Trump and China President Xi Jinping fails to ease the trade war. Markets then recovered overnight after Trump expressed some optimism that a trade deal could be reached. So, which is it? The currency market seems to be betting on the latter, speculating that the recent pain in U.S. stocks might encourage Trump to reach some deal sooner rather than later. At least that’s the signal being sent by the Australian and New Zealand dollars, two currencies that stand to benefit the most from an easing of trade tensions given their economic ties to China. The currencies were the biggest gainers against the U.S. dollar on Tuesday after Turkey’s lira. Bloomberg indexes that track the currencies against a basket of 10 developed-market peers showed big gains not only for the day but for the past week and the past month. That’s impressive given how strong the greenback has been, with the Bloomberg Dollar Spot Index on pace for its best monthly performance since November 2016. It would be easy to wave off the gains in the so-called Aussie and kiwi by saying they were just a knee-jerk reaction until you realize the currencies continued to strengthen throughout U.S. trading hours.
S&P FIRES WARNING SHOT AT THE POUND
As if there wasn’t enough pressure on U.K. Prime Minister Theresa May to reach a deal on leaving the European Union, along comes S&P to say that the risk of a so-called Brexit that doesn’t include a trade deal has sufficiently increased to the point where the country’s AA credit rating is in jeopardy of being cut. Currency traders didn’t take kindly to that, pushing the pound down to its lowest level since August against a basket of nine developed-market peers. A no-deal Brexit would result in a “moderate recession” for as many as five quarters in the U.K., with the economy contracting by 1.2 percent in 2019 and 1.5 percent in 2020, the ratings company said in a statement Tuesday. In such a scenario, unemployment would rise from record-low levels to more than 7 percent by 2020 — a level not seen since the financial crisis, according to Bloomberg News’s Anurag Kotoky, citing S&P. May is stuck in a deadlock as her attempts to reach a compromise with the EU — primarily on the issue of avoiding customs checks at the Irish border— has been blocked by her own party members. As one of the world’s 10 biggest economies, such a scenario should worry market participants beyond just those who trade U.K. financial assets.
BAD DAYS IN COMMODITIES KEEP PILING UP . . .
… which maybe isn’t so bad. The Bloomberg Commodity Index that tracks 22 raw materials from oil to copper to hogs fell to its lowest level in more than five weeks Tuesday. At one point, it was down as much as 1.14 percent in its biggest drop since mid-August. No part of the market was spared, with energy, base metals and agriculture prices all declining. Given how broad and diverse the commodities market is, it’s almost impossible to attribute the move to a single reason, but it would be hard not to think that at least the diminished outlook for inflation has something to do with it. Broadly speaking, commodities are a good hedge against faster inflation. So if inflation is less of a threat, then some of the reasons for owning commodities no longer make sense. Overlaying the Bloomberg Commodity Index with breakeven rates on five-year Treasuries — a measure of what bond traders expect the rate of inflation to be over the life of the securities — shows the two move in an almost lockstep manner. It’s notable that breakeven rates have dropped to their lowest level of the year. The upshot is that a slowdown in inflation may induce the Fed to slow the pace of interest-rate increases sooner rather than later.
The ADP Research Institute will release on Wednesday its monthly employment report, with economists forecasting a drop to 187,000 jobs added in October from September’s 230,000. Economists go out of their way to point out that the ADP report has little to no correlation with the more important monthly jobs report put out by the Labor Department, which typically comes out on the first Friday of every month. Still, the ADP will have some valuable information in terms of individual industries. Bloomberg Economics says that given the recent deterioration in a broad range of housing indicators, it will be interesting to see whether weakening demand in addition to labor shortages will affect builders’ hiring decisions in the construction sector. Also, while manufacturing has shown some impressive strength over the last couple of years, September’s reading for the sector was the weakest in more than a year. The October report will reveal if that was just a temporary stumble or potentially the start of a new trend, with hiring plans impaired by the impact of tariffs. Bloomberg Economics estimates it is more likely to be the former.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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