(Bloomberg Opinion) -- To the jaded, it probably sounds like just another euphemism that Wall Street trots out whenever stocks take a big tumble to gloss over the fact that the market is under severe stress. But when the talking heads describe the recent sell-off that has taken the S&P 500 Index down as much as 9.8 percent this month as little more than a "repricing" of expectations, it actually makes sense.
Stock rebounded a bit on Thursday, with the S&P 500 jumping as much as 2.51 percent on the back of strong earnings results from Twitter Inc., Microsoft Corp. and Tesla Inc. And that's the thing: Earnings are strong, and although profit growth is forecast to decelerate to about a 10 percent pace in 2019 from around 20 percent this year, that's still a very good outcome and a marked improvement from the earnings recession between 2014 and 2016. What’s more, while the economy is forecast to slow, economists aren’t expecting a recession until at least 2020. There's also no real evidence that the weakness in equities is causing any undue stress in the broader financial system, as suggested by the spread between three-month forward rate agreements and overnight index swaps. That may sound technical, but it's basically where the market expects short-term bank funding costs to be in three months. A wider spread is a sign the market expects the banking system to come under stress, so it forces banks to pay more to obtain short-term funds. Although the gap has jumped to 36.1 basis points from 19 basis points in mid-September, it's still far below the 53 basis points reached in March. During the height of the financial crisis in late 2008, the spread grew to 170.3 basis points.
The downdraft in stocks has been "heavily influenced by emotion," Jack Ablin, the chief investment officer at Cresset Asset Management, told Bloomberg News. “I’m not really seeing other factors confirming the markets rout, and I’ve been trying really hard.” Here's another reason to be optimistic: Since 1950, there have been seven other years when the S&P 500 was positive for the year at the end of September, but fell into negative territory during the month of October, according to LPL Research. The S&P 500 was higher in the final two months of those years six times, rising 4.1 percent on average.
MORTGAGE BONDS SEND A MESSAGE
Evidence is mounting that the housing market might be in the early stages of a rough patch. No one is predicting a crash like during the financial crisis, but home sales are slowing as higher mortgage rates eat into affordability. Purchases of new U.S. homes fell in September by more than estimated to the weakest pace since December 2016, government data Wednesday showed. Even bond traders, it seems are, getting nervous. They've pushed yields on 30-year Fannie Mae current coupon mortgage bonds to their highest since mid-2016 relative to yields on Treasury 10-year notes. A wider spread is often an indication that traders see greater risk in buying mortgage bonds. To be sure, there's little evidence yet that borrowers are having trouble meeting their debt payments. Fannie Mae data released earlier this week showed that just 0.82 percent of all single-family mortgage loans are 90 days or more delinquent, down from 1.24 percent a year ago and well below the recent peak of 5.59 percent in 2010. Nevertheless, financial markets are always forward-looking, and it appears bond traders may be bracing for what happens when all those adjustable-rate mortgages that were taken out in recent years reset at higher rates in 2019 and beyond. But there is an upside: The decline in home sales means fewer loans will be made in coming months, which means that fewer mortgage-backed securities will be created, keeping a lid on supply.
EURO TRADERS DOUBT DRAGHI
European Central Bank President Mario Draghi said all the things the euro bulls wanted to hear on Thursday. He played down risks to the euro zone economy and said the ECB is on track to wind down its stimulus program. The “underlying strength of the economy continues to support our confidence,” Draghi told reporters. And yet, the Bloomberg Euro Index that tracks the currency against its major peers fell to its lowest since mid-August, which just happens to be around its weakest levels of the last 16 months. That suggests that currency traders aren't buying what Draghi is selling. And why should they? The recent economic data has been dismal. The Citigroup Inc. economic surprise index covering the euro zone shows that incoming data is falling short of estimates by the greatest degree since early July. A gauge for private-sector growth in the euro area slowed to the weakest since 2016 — a level IHS Markit said Wednesday “would historically be consistent with a bias toward loosening monetary policy.” The German economy may have stalled temporarily in the third quarter as automakers grapple with new emissions testing, the Bundesbank said earlier this week. Draghi spoke after the Governing Council confirmed it still expects to cap bond buying under its 2.6 trillion ($3 trillion) asset-purchase program at the end of the year. It reiterated plans to keep rates at their current record lows through mid-2019.
PARIAH NO MORE
It appears that the international investment community isn't holding the death of Saudi journalist and Washington Post columnist Jamal Khashoggi in Turkey against the kingdom. Saudi Arabia’s main stock gauge surged the most since June 2017 on Thursday, rising 4.30 percent and bucking a global sell-off in emerging markets. The Tadawul All Share Index is now up 7.83 percent from this month's low on Oct. 14. Crown Prince Mohammed bin Salman said on Wednesday he would bring Khashoggi’s killers to justice in a speech that signaled confidence in his authority, even as international outrage refuses to abate, according to Bloomberg News's Filipe Pacheco. The continuing focus on Saudi Arabia's role in the killing “will probably create some negative headlines but at the end of the day, people will forget after a while and it will have minimum impact on Saudi Arabia’s economic activities and also the credit quality,” Carl Wong, a senior money manager at Hong Kong-based Nexus Investment Advisors Ltd., told Bloomberg News. Others agreed. “There was a positive tone to his speech reinforcing changes in the country that are here to stay," Ali Taqi, the head of equities at Rasmala Investment Bank Ltd in Dubai, also told Bloomberg News. "It was reassuring for confidence domestically, in general. It was definitely positive.”
COMMODITIES CRUMBLE
Inflation expectations in the U.S. bond market have dropped to their lowest since January, and many have pointed to the decline in oil prices as a big reason why that's happened. But now, the rest of the commodities market is starting to track oil lower, putting further downward pressure on inflation expectations and potentially having an impact on how the Fed views the path for monetary policy. The Bloomberg Commodity Index fell for a fourth straight day Thursday in its longest slump since the first half of August. Wheat markets were particularly hard hit, posting their biggest two-day drop in seven weeks as U.S. export sales slumped and the outlook improved for crops in Russia, the world’s top shipper, according to Bloomberg News's Anatoly Medetsky and Jen Skerritt. In the week ended Oct. 18, U.S. export sales fell 5.8% from a week earlier, USDA data showed Thursday. Heavy rain started across Russia on Wednesday, easing dryness in previous weeks that stressed crops seeded for next year’s harvest. Corn and soybeans were also big decliners among agriculture products Thursday, along with orange juice, cattle and hogs. In the metals market, aluminum, zinc and nickel all fell.
TEA LEAVES
When the Commerce Department releases its gross domestic product report for the third quarter on Friday, the headlines are likely to point out that the U.S. economy enjoyed its best back-to-back quarterly performance since 2014. And that be would true, with forecasters predicting the economy expanded at a 3.3 percent annualized pace in the July-September period after a 4.2 percent gain in the April-June period. What's also true is the report will likely mark a turning point for the economy. Forecasters predict that growth is now decelerating, and will continue to do so through the end of next year amid higher interest rates and as the Trump administration's corporate tax cuts have less of an impact. "To be sure, the economy is on sturdy footing — and poised to grow at an above-trend pace for the foreseeable future — but fading fiscal stimulus will ease growth toward a more sustainable pace over the medium term," the Bloomberg Economics team wrote in a report. Also likely to get a lot of attention is the part of the report that addresses inflation. The core personal consumption expenditure index, which excludes food and energy cost, is seen rising 1.8 percent rate in the quarter, down from a 2.1 percent increase in the prior period and below the Fed's 2 percent target.
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What Is Bill Gross's Fund Betting on Anymore?: Brian Chappatta
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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