Pro Perspectives 10/29/19

October 29, 2019

The Fed decides on monetary policy tomorrow. 

The interest rate market is pricing in a 97% chance of a 25 bps cut — leaning heavily in favor of a third consecutive rate cut in this flip-flop campaign.

This, despite a very different climate than they entered for their September meeting, where they cut for a second consecutive time.

Then:  In September, the uncertainty of an indefinite trade war was at peak levels.

Now: Three weeks later, Trump and the Chinese Vice Premier shook hands in the Oval Office on a limited deal.   

Then: We were closing in on an October 31 deadline for Brexit that was looking like a “no-deal” was coming.

Now: Four weeks later, we have an agreement on Brexit terms between the UK and EU.

With these developments, what is the Fed thinking?

We did hear from the Fed Chair on October 8th at an economic conference.  He made a few very important statements that should give us clues on what tomorrow’s announcement and press conference will look like — and these clues support the market’s view toward a rate cut. 

Back on October 8th, Powell said:

1) “In the 90s the Fed added support to help the economy gather steam, that’s the spirit in which we are doing this (easing).”  The Fed cut three times over a six month period starting in July of 1995.

2) “There are concerns surrounding business investment, manufacturing and trade.”  On October 1, the ISM report showed that manufacturing contracted for a second consecutive month in September.

3) The “time is now upon us” to expand the balance sheet.  The Fed is back to expanding the balance sheet in response to a disruption in short-term lending markets stemming from the Fed’s quantitative tightening program (i.e. the Fed is in the mode of reversing its over bad policy/overly-aggressive tightening mistakes).

So, despite the clearing trade war overhang, the above three comments from the Fed three weeks ago should keep the Fed on track tomorrow for another cut.

Pro Perspectives 10/28/19

October 28, 2019

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Thanks in advance!  Now, onto today’s note …

Stocks have lifted off to new record highs as we start the week.

We have a Fed meeting mid-week, and that will be followed by a Bank of Japan meeting.

While the market is pricing in a third rate cut in the Fed’s flip-flop campaign, let’s take a look at the most important Fed-related chart…

This is a look at the Fed’s balance sheet.

Remember, it was not only the Fed’s rate path of the past three years that ultimately shook market late last year, it was the withdrawal of global liquidity, and the signals given by the Fed and the ECB that it would continue, if not accelerate.  This was thanks to the one-two punch of the Fed’s mechanical process of shrinking its balance sheet and the end of the ECB’s QE program. 

This sent global interest rates haywire, plunging, in many cases, into negative yield territory.  What has turned the tide?  Balance sheet expansion is back!

The Fed quit shrinking the balance sheet in July, and as you can see in the chart above, they have been back to expanding the balance sheet again.

Add to that, as of next week, the ECB will be back in the business of QE.

So, what happens when the balance sheets of the two most powerful central banks in the world are expanding?  The history of the past decade tells us, stocks go up.  And despite the fact that central banks are buying government bonds, bond prices go down (yields go up). 

That’s what we’re getting.

Below is the chart of U.S. stocks, breaking out to new record highs …
And here’s a look at U.S. 10 year yields, bottoming as the Fed starts expanding the balance sheet again (in September) and a break of the downtrend looks like it’s coming … 

 

Pro Perspectives 10/25/19

October 25, 2019

With the big Microsoft earnings beat yesterday, and the miss from Amazon, I want to revisit my notes from earlier this summer on the "disruptors" and the "disrupted."

As I've said, with the regulatory screws tightening on the disruptors, we may finally be entering the stage where we see the disrupted/survivors, competing, if not beating the disruptors.  If the "giants of industry" have moved aggressively to align with the changing economy, they have the distribution, in many cases, to be the ultimate winner.   

We're seeing it with Microsoft and Amazon (maybe signs of it).   

Remember, thanks to the strategy reset that took place five years ago, Microsoft is part of the duopoly in cloud computing (and taking share).  MSFT grew cloud revenue by 59% last quarter.  Amazon grew AWS (cloud) revenue at 35%, the slowest rate in the five years.  How have the stocks done?  

Microsoft has transformed and become one of two trillion-dollar companies (along with Apple). 

Let’s revisit the Walmart/Amazon battle too — another great example.  The market has priced Amazon like a runaway monopoly — killer of all industries, especially retail.  And the perception has been that Walmart was destined to become another rise and fall story of a dominant American retailer.  Sears, Toys R Us and about 70 other retailers have gone under in the last four years. 

But Walmart has been transforming.  
 

Walmart has been aggressively investing in online. They bought Jet.com in 2016, an American online retailer.  That same year they took a large stake in the number two online retailer in China, JD.com.  
 
JD.com already has a big share of ecommerce in China.  They are number two to Alibaba, but gaining ground due to some clear competitive advantages.  JD owns and controls its logistics infrastructure, and does quality control from the supplier to delivery.  And unlike Alibaba, JD sources product to its warehouses to fight the counterfeit goods risk – a big problem in China. JD has 500+ warehouses around the country, and they now source product and service customers from one of the more than 400 Walmart stores in China. 

So Walmart is positioned well to take advantage of the growth in the middle class in China.  Amazon has yet to find its way in China.  It has about 1% market share.   Add to this, Google came in last year with a $550 million investment to help position JD to challenge Alibaba and Amazon on a global scale.  Walmart is still about a third of the value of Amazon, but the gap has been closing (slowly). 

Lastly, let's look at Netflix and the response underway at Disney.  In recent years, Netflix has been thought to be taking over the entertainment industry with its disruptive direct-to-consumer model. 

Fox responded early and aggressively (thanks the activist investor, Jeff Ubben).  They made an aggressive move to build the direct-to-consumer model (taking stakes in Hulu, Star India and Sky).  That set the company up as an acquisition target.  And now with the Disney acquisition of Fox, Disney is positioned with a dominant duel threat — among the world's deepest and most valuable library of content and the distribution to take it to the consumer.  This makes the world's preeminent entertainment company.

The result?  Disney's valuation has leapfrogged Netflix.  Disney now has a market cap of $236 billion. That's twice the value of Netflix now. 

 

Pro Perspectives 10/24/19

October 24, 2019

The ECB met this morning and made no adjustment to the plans to restart QE.  Why does the ECB matter?

Remember, by the ECB ending it's three-year QE program last December, a stabilizer of global liquidity was removed – an offset to the Fed's QT was removed.  With that, a shrinking global balance sheet of the top three central banks in the world proved disruptive for global markets and the global economy.  We now have the ECB back in the QE business.  And the Fed has not only stopped QT, but is now expanding its balance sheet again.  

This was Mario Draghi's last meeting and press conference as head of the ECB.   This is the man that led the strategy to avert disaster for Europe and the global economy back in 2012. A contagion of global sovereign debt defaults were lining up in Europe.  And the second most widely held currency in the world, the euro, was vulnerable to a break-up.  To stop the meltdown, Draghi publicly threatened/vowed to become the backstop in the European government bond market.   

Here's what he said in a July 2012 speech: "the ECB is ready to do whatever it takes to preserve the euro.  And believe me, it will be enough."

The imminent risk was sharply rising yields in the big, dangerous weak spots in Europe:  Spain and Italy.  Speculators were hitting the bond market, yields were rising to unsustainable levels.  Spain and Italy were on the path of default and once one went, the others would fall.  The next step would mean these countries leaving the euro, returning to national currencies and inflating away the debt through currency devaluations. 

It didn't happen because Draghi stepped in.  With the statement above, he threatened to be the unlimited buyer of these troubled government bonds, which was enough to purge the speculators from the market.  Quickly the yields on those bonds plunged, without Draghi having to buy a single bond. 

Here's what the chart of those bond yields looks like …
 
Trouble in Europe means trouble for the global economy.  So, when the rules aren't working, don't underestimate the appetite of policymakers to change the rules.  That's what Draghi did.  He backstopped the bond crisis, and later launched QE.  The global economic recovery was back on path.
 

Now, in this post-financial crisis world, as long as everyone's fate is interconnected, there are few, if any, market penalties for what may seem to be desperate, dangerous and profligate actions.

With that, we've talked about the prospects of the ECB turning to the stock markets — to become buyers of stocks, to help boost wealth, confidence, hiring, spending and investment.  When Draghi was asked today about the options the ECB has to enlarge the composition of the asset purchase program, he ignored the question and went into a long-winded answer about something else.   That's the elephant in the room.  The WSJ ran a piece today saying the ECB would run out of bonds to buy by the end of next year — proposing equities as an option. 

 

Pro Perspectives 10/22/19

October 23, 2019

The European Central Bank will meet tomorrow.  Remember, in September, they announced they would restart QE. 

We've since had softer euro area inflation, manufacturing and confidence data — and softer manufacturing data, globally.

Now, the ECB's decision to get back in the QE business was clearly driven by the downside risks associated with an indefinite global trade tensions and the prospects of no-deal on Brexit.  And we now have what looks like a deal on U.S./China trade and Brexit. 

 
Problems solved? 
 
No. While potentially dialing down tariffs on China, Trump slapped tariffs on Europe.  And while Europe now has more certainty the terms of Brexit, they have to manage the downside risks of the outcome.  

So, will they have to up-the-ante?  Yesterday we revisited the "bazooka" option for the ECB:  buying stocks. 

 
Why would they buy stocks?

As we discussed last month, negative rates haven't worked in Europe, because the policies aren't forcing savers into higher risk assets. It's not in their culture to buy stocks. 

 

The ECB's explicit presence in European stock markets would reduce the risk premium in stocks, which incentivizes capital flows out of negative yielding bonds and into higher returning stocks.  And a higher stock market would go a long way toward driving, confidence, investment and ultimate economic demand. 

With this in mind, European stocks continue to be the spot to watch.  European blue chips have a long way to go to catch up with the peformance of U.S. blue chips over the past decade, and the past five years …

Pro Perspectives 10/22/19

October 22, 2019

We've talked about the Brexit deal over the past few days. 
 
The deal that was struck between the UK Prime Minister and EU officials last week, was indeed approved by Parliament today! 

However, what wasn't approved today, was the timeline on how long it will take Parliament to agree on how to legislate it.  With that, the formal exit of the UK from the EU may happen at the end of month, or may not.  The ugly process of law making will likely take longer than nine days, but importantly, this continues to signal that both sides are ready to move on — as we've seen in the case of U.S./China trade dispute.  The removal of uncertainty is good for the global economic outlook.

But EU officials now have more certainty on what the deal looks like for Europe. 

With the above in mind, we have a big European Central Bank meeting on Thursday.  Remember, last month, the ECB announced that it was going back in the QE business, to start buying assets again in November.

Their stated plan, at the moment, is not to change the asset mix from their past asset purchases, which consists of corporate and sovereign bonds.  The question is, will the ECB step up the firepower, to manage any increased downside risks associated with the terms of the Brexit deal? 

As we've discussed here, adding European equities would be the "bazooka" of monetary stimulus for the European economy. 

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Pro Perspectives 10/21/19

October 21, 2019

We entered the weekend with another big vote due in the UK on Brexit (perhaps a final vote). 
 
What did they do?  They delayed it.  But the delay came with an amendment that makes a "no deal" Brexit less likely.  With that, and with the drama last week in Brussels, it looks almost like Trump's deal with China.  It looks like capitulation from both sides in both issues (Brexit and U.S./China trade).  Everyone seems to be acknowledging, given the state of the global economy, it's time to move on.  
  
Most importantly, for markets, this looks like we have removed another overhang of uncertainty. 
 
Now, where do we look to take the market temperature on the Brexit issue?  The British pound, which held up nicely today, despite the delay and the continued debate in UK parliament throughout the day.  And, as you can see, the pound has broken the downtrend of the past year and a half. 
 
The next spot to look for the temperature on a Brexit resolution is German bunds.  And yields on German debt are testing a technical trend break from deep negative yield territory, signaling an improving outlook. 
With German yields leading the way, the euro benefits, which makes this chart the next place to look.  And the euro is testing a big trend break too. 
With the euro threatening a bullish breakout, and with Trump and China allegedly forming a currency pact, it's no surprise the dollar outlook should be lower.  And this chart confirms it, with a breakdown underway.
If the prospects of a no-deal Brexit and an indefinite trade war have now been removed from the probable scenarios, then the outlook for gold deteriorates.
As you can see, the trend in gold looks vulnerable here too. 

But, if the removal of the trade war threat does indeed unleash animal spirits in the economy, especially with central banks in an ultra-easy stance, inflation could start finally moving…and quickly.  Then you buy gold again.

 

 

Pro Perspectives 10/18/19

October 18, 2019

UK parliament will vote on a Brexit deal with the EU tomorrow.

Remember, this is a deal based on the 2016 referendum where UK citizens narrowly voted in favor of leaving the EU (52 to 48).  

That gap would have been wider had it not been for a coordinated campaign by global leaders threatening a draconian outcome. 

With that, there was public shame associated with voting for the "unknown" over the "known."  But when left to the privacy of an individual vote, the people chose the unknown outcome as better than the known outcome.

But as we saw with Grexit, Brexit has created leverage. 

Despite the dire warnings for UK citizens, the reality is, everyone loses if the EU (and other world trading partners) were to turn their backs on the UK. 

The EU bluffed that it would play hard ball.  But as we near the finish line, they have agreed to establish free trade — no tariffs, no quotas.  And despite the warning by President Obama (in 2016) that the UK would be put in the "back of the queue" for a bilateral trade agreement, Trump has promised a "big trade deal" by July, following their exit.

With the above in mind, a withdrawal agreement has failed twice already in the House of Commons.  But given the fragility of the global economy, the state of global trade (with U.S. tariff escalations now including Europe), and the fatigue of the long, ugly Brexit path and negotiations, I suspect we get an approval of withdrawal, with the goal of moving on to the next chapter. 

 

 

Pro Perspectives 10/17/19

October 17, 2019

In the spirit of dealmaking, after the U.S. and China came to terms on a (limited) deal on trade last Friday, the UK and EU leaders came to a deal this morning on Brexit.

The deal will go to a vote in the House of Commons on Saturday.  At the moment, the bookmakers in the UK are still showing a better chance that the deal won't be approved on Saturday, and rather the October 31 hard deadline will be extended. We will see.

If we look at the currency markets, as a gauge, the response is positive.  Both the euro and the pound have been rising all month in anticipation of a deal, as we have been headed toward the impending October 31 deadline.    

Listening to the press conferences today, the tone of the UK/EU deal sounds much like the tone of the U.S./China deal — both sides (in both deals) capitulating to get it done and move on.

It seems that all parties involved have come to the realization that not only is global economic sentiment eroding, it's beginning to show up in the data.  And if left to evaporate, it would be very dangerous for the global economy.  Perhaps that's why both Europe and the Chinese had the similar comments to make about the respective deals:  China's Vice Premier said its about "peace and prosperity for the whole world."  The President of the European Commission said today that the deal is about "people and peace."

 

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Pro Perspectives 10/16/19

October 16, 2019

The start of third quarter earnings season has been overshadowed by macro events thus far (trade and Brexit negotiations), but earnings the numbers have been good.

Remember, never underestimate the appetite of Wall Street and corporate America to dial down expectations when given the opportunity.  
As we discussed when the third quarter ended, estimates had already been ratcheted down, to fit the recession narrative that had been going around.  That view has since been lowered even more.  The street is looking for a 4.6% year-over-year decline in S&P 500 earnings in Q3.

So, we came into earnings season with the table set for positive surprises.  

And we're getting it.  About eight out of ten companies have beat earnings estimates so far, showing year-over-year growth, not contraction.  But it's still early. 

With Bank of America earnings today, we've now heard from all of the big four banks (JPM, BAC, WFC and C).  We've seen big positive surprises in the banks from Q4 of 2018 through Q2 (all against dailed down expectations).

But the banks have generally not just shown good performance against the low bar of expectations, the year-over-year growth has been strong too.  The key contributor has been a strong consumer.

So, how did the banks look in Q3?  We've had positive earnings surprises Citi, JPM and Bank of America for an average year-over-year earnings growth of 14%. That is strong. Though Wells Fargo was the outlier, missing on expectations, as they took some pain preparing for a new CEO to start next Monday.

The earnings strength from the major banks (three of the major banks, in the case of Q3) follows 21% average year-over-year EPS growth from the big four in Q2.  Again, the consumer has not faded, despite a nine month public debate over recession cues.  

And remember, we looked at this chart from Citigroup’s Economic Surprise Index as we ended Q3 …

This chart doesn't fit with the earnings expectations/ recession story. 

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