Let’s step back from the day to day noise of newswires, and journalist opinions on infectious disease, and revisit what is an exciting outlook for stocks and the economy.
Remember, along the way last year, we were looking for a repeat of 1995, where the Fed was forced to reverse course on interest rates. We got it. And we got a big outcome for stocks.
And with that flip-flop by the Fed, we’ve talked about the prospects of seeing another big late 90s-type of run for stocks and the economy. After the Fed cut rates in July of 1995, the economy went on to average 4.5% quarterly annualized growth through the end of the 90s. Stocks were up big every year through 1999, with an annual average return of 26%.
Remember, we never had the big bounce back in growth, following the Great Recession. Historically, significant economic downturns are followed by a big bounce back in growth. For the 10-years following the Great Recession, the economy has grown at right around 2% annualized. That weak recovery has left the U.S. economy about $4 trillion smaller than it would be had we returned to the path of long-term trend growth (3%). This outlook of another late 90s boom would be a needed “catch up” for the U.S. economy.
So, with this in mind, we are in the midst of the longest economic expansion on record. As Bernanke has said, “economic expansions don’t die of old age, they tend to be murdered.” The Fed kills them through aggressive tightening, in fear of getting behind on inflation.
The good news. That seems unlikely this time around. For the Fed’s part, Powell has made it clear that there will be no rate hikes until it sees significant and sustained inflation above its 2% target. That should be the formula for a boom period.
Jerome Powell just spent two days on Capitol Hill, making prepared remarks to Congress on the economy, and then painfully entertaining their questions/ monologues.
The message from Powell hasn't changed. The economy is good and inflation is tame, yet they stand ready to act against changes to that view.
What could change that view? The old risk to that view was an indefinite trade war. The new risk to that view is the unknown outcome of the coronavirus. But the former already forced the Fed and the ECB back into balance sheet expansion. And the latter has the central bank in China flooding China, and global markets, with liquidity.
If we think about the primary purpose of this liquidity deluge: It's to stabilize and/or restore confidence. Confidence is the key ingredient in keeping the economic engine going. Through low rates, balance sheet expansion, and credit creation, the Fed has proven over the past decade to be able to promote higher stock prices and higher housing prices. That has translated into hiring, spending and investing, which has translated into economic activity — all despite a myriad of threatening crises.
So, currently we have record high stocks, a strong housing market, and solid economic data. It appears that the central banks (led by the Fed) have again been successful in using the balance sheet to stabilize confidence (which was waning in the third quarter last year).
This should be a powerful line of defense against a reduction in global growth from the health crisis in China. Still, the market is pricing in more Fed rate cuts – a coin flips chance of at least one rate cut by July. And by the end of the year, the market is pricing in a near 80% chance of at least one cut – and plenty of bets are being place on several cuts.
This is either reflecting the view of the coronavirus turning into a global pandemic, which would be far too conservative in pricing in just a rate cut or two. Or it's reflecting a view that the U.S. economy isn't any better today, than it has been over the past decade. Both seem like very low probability scenarios (unsupported by the data).
What's clear is that the market is leaning heavily one way. If this health crisis threat were to clear in the coming weeks, the economy would be positioned for a big upside surprise in growth into the end of the year. This brings in the other side of what could change the Fed's view: hotter inflation. That's my bet.
If you turned on the TV today, read the newspaper, surfed the internet, or checked social media, you heard about the big Sprint/T-Mobile court ruling.
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As we entered last week, the PBOC had rolled out an arsenal of policy measures (including a quarter of a trillion dollar liquidity injection into the Chinese financial system). And they did so with confidence that they could be the backstop for the Chinese economy and for global confidence, and therefore become a "put" against downside risks in global financial market.
So far, mission accomplished. The S&P 500 futures, the proxy of global investor confidence, is near record highs again, up 3.7% from the lows of last week.
And with a quarter of a trillion dollars of Chinese money undoubtedly being put to work in global markets, let's take a look at some opportunities in European stocks.
Like U.S. stocks, German stocks are on (or near) record highs. But there are very compelling laggards in Europe. Italian stocks are well off of record highs, still 44% off of the pre-global financial crisis highs. And you see in the chart below, the FTSE MIB traded today to the highest level since October of 2008.
Next, here's a look at Spanish stocks. It looks like a big breakout may be underway here too, with a break and three closes above this big trendline. This line comes in from the 2007 highs. Spanish stocks remain 38% off of those highs.
As we end the week, let's take a look at the state of the big "disruptors" following Uber's earnings report yesterday.
It was a little less than a year ago that Lyft IPO'd. And Uber went public about a month later. Based on the first day trading of Lyft and the early indications on how Uber would be priced, the ride sharing industry was being valued at an absurd 14 times the size of the traditional rental car industry. As I said last year, "Lyft and Uber, dumping shares on the public at a combined $140 billion plus valuation, may mark the end to the Silicon Valley boom cycle."
When Lyft went public, Silicon Valley VCs were dumping a company on the public that was doing $2 billion in revenue and losing $1 billion. Today the company does $3.5 billion and losses $2.6 billion.
When Uber went public it was doing $11 billion in revenue, and losing $4.2 billion. Now it does $13 billion in revenue and loses $8.7 billion.
In both cases (Lyft and Uber) we had over-hyped "hyper-growth" companies with slowing revenue growth and widening losses. Now, less than a year later, the growth continues to slow and the losses continue to widen, and the two companies are worth $85 billion, not $140 billion — in a stock market sitting near record highs.
The era of paying $1.60 for a dollar of revenue, and then turning back to Silicon Valley for another injection of cash is over.
The question is, will Wall Street pick up where Silicon Valley left off, funding business models (the "disruptors) that are monopoly hunting/designed to destroy the competition with predatorial pricing? Unlikely. More unlikely: Washington allowing it to happen.
On Monday, we talked about two markets to watch that would likely dictate the sentiment in global markets in the coming days: Chinese stocks and the Chinese currency (the yuan).
Both opened the week with a big gap down. But both have since been recovering nicely, driven by the policy response of the Chinese central bank, by the direction of the Chinese government.
Here's a look at Chinese stocks, up 7% from the Tuesday lows …
Indeed, this has translated into higher global markets, and less fear about a draconian outcome from the coronavirus.
With that, low rates, expanding global central bank balance sheets and a fundamentally solid economy, U.S. stocks are back on record highs.
Supportive of that, we continue to get positive surprises in fourth quarter earnings. Global manufacturing data (the concern of last year) is bouncing back, following the U.S./China trade deal. And we're going to get another big jobs number tomorrow.
With the impeachment circus now over, and the pandemic threat softening, will Trump turn toward the next pillar of Trumponomics: infrastructure.
It seems unlikely. In Tuesday's State of the Union address, he only made one mention of it. And he was urging Congress to pass a transportation bill that's been on the table since mid-19. This is a fraction of the spend of the $1-$2 trillion deal he was negotiating with Congress two years ago. Perhaps he's looking to give less and get more of what he wants out of an infrastructure spend. That would mean infrastructure will be addressed after the election.
As we discussed yesterday, the elaborate measures China took on Monday and Tuesday to shore up the economy and financial markets were a big deal, not just for Chinese markets but for global financial markets.
They articulated their response in a document titled, "Strengthen Confidence and Join Forces to Foster Effective Financial Support for Epidemic Control and the Real Economy." You can see it here. This document laid out the coordinated effort in China, under the direction of President Xi, and was explicit in their confidence and efforts to become the "put" for global markets. So far, mission accomplished.
If there's one thing we know from the events of the past decade (post-financial crisis), with $3 trillion in currency reserves, a pegged/artificially weak currency, and with global trade partners unwilling to poke the bear, they can print yuan and fund whatever they need or want to.
In early 2009, when commodities were crushed under the weight of a global credit freeze and demand destruction, China came in as the big buyer, "building strategic stockpiles" (as it was described in a Bloomberg article at the time). Commodities bounced sharply from the lows …
Despite a global economy that was still sucking wind for the years following the failure of Lehman Brothers, oil went from crashing to from $147 to under $30, to running back up to $100/barrell …
With the above in mind, as I said yesterday, I suspect they turn to the beaten-down commodities markets next and start stockpiling cheap commodities again.
Here is what that broad commodities chart looks like now …
In the face of a pandemic threat, yesterday we talked about the two spots to watch in the coming days that will dictate broader global market sentiment.
One was Chinese stocks. The other was the Chinese currency (the yuan).
It turns out, it was the yuan, overnight, that set the tone for an explosive rally today in global stock markets.
As we discussed, the currency is where we see China's perception on how economically damaging they perceive the coronavirus to be. Weakening the yuan has been the go-to tool for priming exports and pumping up economic activity in China for three decades. When things get bad, expect them to weaken the yuan.
After weakening the yuan more than 1% on Sunday night, to above the 7 yuan per dollar level (a big psychological level), the expectation was for another adjustment lower. But the Chinese central bank reversed course, and reset it back under 7.00. That was a signal.
It may seem like trivial adjustments in the currency, but what China does with the yuan is (and has been) a major policy signal. Importantly, they accompanied this with another injection of liquidity into the system. This adds up to a quarter of a trillion dollars pumped into the financial system since Sunday, to keep credit flowing and to (in their words) "keep ample liquidity in financial markets."
So, with a ban on shorting Chinese stocks already in place, and a war chest of capital at the disposal of state-owned banks and brokerages, what do they do with all of that cash? They go on a buying spree, to stabilize not just domestic markets, but global markets.
This massive buying interest was clear across Asian stock markets very early in the session overnight. It was unabated, and that carried on through Europe and the U.S. What is behind the big surge in Tesla, up 44% in two days? Likely a huge, relentless buying wave from China, which has forced the short sellers to run for the doors (exacerbating the move).
So, does this move in the currency overnight reflect optimism about the coronavirus outcome? Maybe. What it does signal is that China can, and is willing to, print unlimited money to (in their words) "prop up" the financial market. My guess is that they turn to the beaten-down commodities markets next and start stockpiling cheap commodities (again, as they did in 2010).
The Chinese stock market re-opened overnight, after being closed for a week, for the Lunar New Year. That holiday week just happened to coincide with the outbreak of the coronavirus.
So, heading into what was promising to be a disastrous day for Chinese stocks, the Chinese government got in front of it with large intervention — injecting $174 billion into the markets (adding to bank liquidity). That gave the banks a deluge of cash with which they undoubtedly became buyers of stocks — helping that effort, the Chinese government suspended short selling. And we got this big 9% gap down on the open, and drift higher.
Meanwhile, the Chinese government moved the value of the yuan back above 7 yuan per dollar (the orange line rising represents a weaker yuan, stronger dollar).
These two spots (stocks and the yuan) will likely dictate the sentiment in global markets in the coming days, unless there is new news on the trajectory of the pandemic threat. The extent to which the Chinese government walks down the value of the yuan will be a good gauge as to how economically damaging (and uncertain) they perceive this health crisis to be.
Because of this chart …
China's economy, the second largest in the world, has already been running at recession-like economic activity, before the outbreak. It's hard to imagine that number not plunging considerably in Q1, despite the massive liquidity injection. CNBC said half of China is shut down, and those parts accounted for more than 80% of national GDP last year.
We end the week and the first month of the year, with continued unknown on how the coronavirus will play out.
And tonight is the formal exit of the UK from the European Union (the famed Brexit).
With that, there continues to be de-risking in markets.
Let's take a look at some charts as we head into the weekened …
Here's a look at UK stocks. The FTSE is up 25% from the 2016 Brexit vote. It is now, as of today, trading below the 200-day moving average.
Here's a look at U.S. stocks…
It was last Friday that we had a sell-off into the weekend driven by a spike in coronavirus fear, which created this technical reversal signal for stocks. As I said, even with the very positive fundamental tailwinds for stocks, that technical signal was hard to ignore. And that signal has worked thus far. We now have a break of this trendline, which represents the rise in stocks following the verbal agreement on trade between the U.S. and China back in October.
We have a similar line that has given way in German stocks.
So, we close the week with global stocks looking bearish. U.S. yields are just above 1.5% — this is getting near the level in yields marked by major inflection points for the global economy over the past seven years: the potential Italian and Spanish debt default in 2012, the Brexit vote in 2016, and the ugliest moment of the U.S./China trade spat in August of last year.
That said, this level of uncertainty isn't showing up in the VIX, which trades at just under 19. Investors aren't paying up for hedges.
