Stock Market Confuses Optimism With Relief

(Bloomberg Opinion) -- The Dow Jones Industrial Average finally joined the S&P 500 Index and Nasdaq Composite Index in setting new highs on Monday. The thing is, the moves appear to be less about optimism over things like growth in the economy or earnings than relief that things aren’t getting any worse.

The gains came as the Commerce Department said durable goods orders fell 1.2% in September, in line with its initial forecast for a 1.1% decline. As for earnings, they are on track to show a drop of 1.8% for the third quarter, which is better than the 4% projected decline. “Not that it’s an unbelievable earnings season, but it’s been so much above expectations,” JJ Kinahan, the chief market strategist at TD Ameritrade, told Bloomberg News. Here’s another way to look at it, though: Earnings have exceeded analysts’ estimates by 3.8%, below the average of 5.2% over the last year and 4.9% the last five years, according to DataTrek Research. And that the so-called beat rate is down even though revenue growth is beating estimates, a sign profit margins are getting squeezed. As a result, analysts are cutting their fourth-quarter forecasts, taking them down by 2.8% during the month of October, which DataTrek points out is steeper than the typical reduction of 1.7% over the last five years.

Equities also got a boost following a report that China is reviewing locations in the U.S. where President Xi Jinping would be willing to meet with Donald Trump to sign the first phase of a trade deal between the world’s two largest economies. Again, this is more relief that maybe the trade war won’t get any worse and drag on the global economy, rather than optimism that it would spur growth. As the JPMorgan Global Manufacturing Index showed on Monday, factory output shrank for a sixth straight month in October.

BOND TRADERS BECALMED
With stocks rallying not only in the U.S, but globally, the bond market naturally took a hit. The yield on the benchmark 10-year Treasury note jumped as much as 8 basis points, or 0.08 percentage point, for its biggest increase since Oct. 10. Still, at 1.79%, the yield is hardly signaling the all clear when it comes to the challenges facing the economy. This time last year, the median estimate of more than 50 economists surveyed by Bloomberg was for the yield to be between 3.42% and 3.49% by now. And it’s not like bond traders are expecting a sudden jump in yields that would accompany a brighter economic outlook. That can be seen in the rapid drop in Bank of America Corp.’s MOVE Index. The measure of anticipated implied volatility has had one of its steepest declines in years over the past four weeks, suggesting bond traders anticipate a period of relative calm in the market even though the Federal Reserve signaled last week that it is done cutting interest rates after three reductions since the end of July. As for what economists see now, they are calling for yields to hover around their current levels through the third quarter of 2020, before slowly creeping up and only breaching the 2% level in the second quarter of 2021. Higher yes, but hardly a level that suggests a buoyant economy.

CENTRAL BANK STIMULUS
Low bond yields globally have contributed much to the rally in equities worldwide. Simple discounted cash-flow analysis shows how lower rates make future earnings more valuable now, justifying higher multiples for equities even without profit growth. But don’t discount central bank largesse. In an effort to combat the global slowdown, major central banks have turned more dovish not just by lowering interest rates, but also by expanding their purchases of financial assets. Led by the Fed’s efforts to unclog the repo market by purchasing more Treasury bills, the collective balance-sheet assets of the Fed, European Central Bank, Bank of Japan and Bank of England rose by 0.6 percentage point to 35.7% of their countries’ total GDP in October, according to data compiled by Bloomberg. The increase from September was the most for any month since March 2017. “Global central banks have delivered an unusual late-cycle dovish pivot this year to extend an already-long economic expansion,” the strategist at the BlackRock Investment Institute wrote in their weekly commentary released Monday. But the firm and others note that major central banks are sending signals that they are hesitant of easing monetary policy further. “The decade-long era of large-scale monetary stimulus is coming to an end,” Mansoor Mohi-uddin, a senior macro strategist at NatWest Markets, wrote in a research note Monday.  “Central bankers increasingly want fiscal policy to share the burden with monetary policy to support growth and inflation.”

UN-PRECIOUS GEMS
Gold, up more than 17% so far in 2019, is enjoying its best year since 2010. This surge can largely be attributed to the big drop in interest rates and rising demand for so-called haven assets amid a slowing global economy. The same can’t be said of diamonds. True, precious gems aren’t exactly a tradeable asset like gold, and they are used mostly for retail transactions, but it’s still concerning that the market for diamonds appears to only be getting worse.  De Beers is taking more drastic steps to stem the crisis in the diamond industry by cutting prices across the board for the first time in years. The world’s biggest diamond producer lowered prices by about 5% at its November sale, according to Bloomberg News’s Thomas Biesheuvel. Part of the problem in the diamond industry is that prices have stagnated as other luxury offerings, like shoes, handbags and resort vacations, crowd the field. It’s also harder for diamond-trading companies to find financing because banks are abandoning the sector after being hit by frauds and bad loans.  The average price for a top-25 quality, 1 carat diamond with a clarity between internally flawless with no inclusions – or marks on the surface – to very slight inclusions has fallen 4.5% in 2019, putting the market on track for its seventh decline in the last eight years, based on the Rapaport Diamond Trade Index.

REACH FOR YIELD ILLUSTRATED
Frontier markets are those that aren’t even developed enough to be considered an emerging market. These are places such as Mozambique, Pakistan and Jamaica. In other words, they’re not suitable for widows and orphans. And yet, these markets have been able to raise $3.2 trillion in the global debt market, according to a report issued Monday by the Institute of International Finance in Washington. The group said that more than two-thirds of the frontier economies it covers have total debt exceeding 100% of their gross domestic product, with borrowings at a record 115% of GDP overall. Although $3.2 trillion may sound like a lot – and it is - it’s actually a very small part of the total debt market, which exceeds $243 trillion. Nevertheless, the number is still pretty remarkable, underscoring just how much demand there has been for any type of debt offering premium yields in a world where some $14 trillion of bonds yield less than zero. And while frontier debt may not be considered systemic risk that could be a threat to the global financial markets, it still bears watching how easily these borrowers will able to refinance the $216 billion of debt coming due through the end of 2021.

TEA LEAVES
Markets will get a very important update on the wealth of the consumer on Tuesday when the Institute for Supply Management releases its monthly services index for October. Unlike its manufacturing gauge, this measure from the ISM hasn’t slipped below 50, which signals contraction, but it has been trending lower. At 52.6, the reading for September was the lowest since 2016, and down from the cycle high of 60.8 in September 2018. The median estimate of economists surveyed by Bloomberg is for an October reading of 53.6, which should alleviate some concern about a slowing economy. Still, Bloomberg Economics notes that a slower pace of consumer spending growth at the end of the third quarter should weigh on the service sector, as well as a manufacturing-sector recession and “broader uncertainty that tends to delay less urgent purchasing and hiring decisions.”

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To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net

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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