October 3, 2019
While the services sector is still expanding. The manufacturing sector is in contraction.
This is the impact of an indefinite trade war on confidence. Weaker confidence, ultimately leads to weaker economic activity.
Until this year, the strategy from the Fed was to ignore it all. They assumed they could keep plugging away at normalizing interest rates and shrinking their balance sheet, all while riding the wave of fiscal stimulus. As long as the economic data was solid, their mistakes were hidden.
But the markets called them out last December, and started pricing in a world where the central banks (led by the Fed) were asleep at the wheel during perhaps the most important step in the post-financial crisis global economic recovery: structural change (i.e. repairing global structural imbalances).
With that, let's take a look at the expectations that are building for another move by the Fed at their end of the month meeting (October 30th).
 |
|
Just a week ago, the market was pricing in a coin flips chance of another quarter point cut from the Fed. Following this week's ISM data, the probability of another rate cut has jumped to 88%.
October 2, 2019 Global stocks took another slide today. Noticeably, European stocks have taken the biggest hit, not just today, but over the past two days.
On that note, the media's attention was given to the U.S. manufacturing data yesterday, to explain the shake up in global financial markets. But was there something more? It appears, maybe so. Today at 10pm EST, the headline hit that the World Trade Organization has sided against a longstanding United States complaint against the EU over subsidies that have been given to the European aircraft maker, AirBus, that have distorted global fair trade and competition — namely, anti-competitive to American aircraft maker, Boeing. The U.S. estimated that the economic benefit of those subsidies, overtime, at more than $200 billion. Now, this headline sounds like an aggressive ramp in Trump trade aggression. But this was a complaint dating back to 2006!
After more than a decade of hearings, and rounds of EU appeals, today, the final decision came down, and on the side of the complainant, the United States. This decision awards the U.S. the right to sanction the $7.5 billion of EU imports related to the case.
Bottom line: The threats of action against EU subsidies have been floated by the Trump administration many times. But now they have the WTO stamp of approval. Comments from a U.S. treasury official hit the wires at the close of the stock market today, saying the U.S. has readied tariffs to retaliate against EU subsidies. With the above in mind, remember, the central banks have now positioned themselves specifically to absorb potential shocks and economic weakness from an indefinite trade war. And this may prove to be the catalyst to move the ECB toward outright stock purchases.
October 1, 2019 Yesterday we talked about the overwhelming weight of positive surprises in the economic data over the past month. Today, we had a big negative surprise in manufacturing data (the September ISM Manufacturing index).
Here's a look at the chart … |
 |
|
As you can see, above the 50 level represents expansion in the manufacturing sector. Below 50 represents contraction. The September number was 47.8, the lowest number in ten years (since the global financial crisis).
Now, if we look back at the dips in 2012 and 2016, they both have commonalities with the present: Central banks responded. In 2012, the ECB pulled out the threat that they will do 'whatever it takes'. The Fed followed by launching its third round of QE (QE3). Later in the year, the ISM number bottomed and turned around. In 2016, following the crash in oil prices, and a contraction in global manufacturing activity, global central banks all responded with action. The BOJ intervened in the currency markets (and likely used the dollars it bought to buy oil, putting a floor under it). China eased reserve ratio requirements. The Fed took four projected rate hikes for the year off of the table. And the ECB ramped up its QE. What about this time? Central banks are responding. The Fed is cutting rates, and has stopped QT (quantitative tightening). China is firing every bullet they have. Global central banks around the world are cutting rates. And the ECB is restarting QE. To follow the stock picks of the world’s best billionaire investors, subscribe at Billionaire's Portfolio.
Bottom line: The central banks are acting! That should support global economic activity, and therefore put a floor under global manufacturing activity. So, within the context of a strong consumer, and ultra-accomodative central banks, positioned to keep the consumer strong and to neutralize the indefinite trade war, this manufacturing data point should not be taken as some Draconian signal that recession is here. With that in mind, after stocks took a hit today on the weak manufacturing number — as did global interest rates and almost all commodities — where do things go from here? We revisited the big 2940 level in the S&P 500 today. We talked about this big level back in August. Here's a look at an excerpt from the Aug 29 note … … we're approaching a big technical level in stocks. |
 |
|
If we get above this key 2,940 area in stocks (the yellow line in the chart above), we could see record highs again, soon.
Here's how the chart looks today …
|
 |
|
As you can see, that level was indeed an inflection point for stocks. Now we are revisiting it, which should make for a good spot to buy, not sell.
September 30, 2019 We end the quarter today. In the coming weeks, we'll see Q3 earnings. What should we expect?
As we discussed last week, estimates have already been ratcheted down. Wall Street is looking for earnings to contract of 3.8% from the same period a year ago. That seems to fit the recession narrative we've been hearing. But is it warranted, or is it Wall Street and corporate America taking advantage of the fear in the air, to set the bar low? Let's take a look at the third quarter. First, take a look at Citigroup's Economic Surprise Index. In the chart below, above the zero line is the degree to which the data is coming in above expectations. |
 |
|
You can see, the positive surprises have been coming in hot over the past month, and the index itself has been on the rise throughout the third quarter. This suprise index behavior typically drives multiple expansion (in stocks) and higher yields. That doesn't fit with the earnings expectations/ recession story.
And it doesn't fit with the Atlanta Fed's forecast for Q3 GDP, which has been on the rise too. |
 |
|
And don't forget, in the quarter, we had two Fed rate cuts, and the Fed's retreat from its Quantitative Tightening program. That has driven the benchmark 10-year yield down from 2.05% to 1.67% in the quarter (cheaper money), and it stabilized stocks near the record highs (fuel for consumer confidence).
Bottom line: The earnings bar has been set low, so that it can be beat. That's the way Wall Street works. So, positive earnings suprises should further underpin stocks as we head into Q4.
September 27, 2019 As we end the week, let's take a look at the IPO market …
Although there have been over 160 IPOs this year, the Silicon Valley "disrupters" get all of the media attention, because Silicon Valley's true competitive advantage isn't innovation, but the deep pockets of Venture Capitalists, using other people's money/i.e. pension funds, to buy media, and craft a story of world changing innovation. They, then, sell dollars for 50 cents, to drive hyper-growth rates in revenues, but also hyper-growth rates in losses. When the public takes the bait on the IPO, the wealth gets transferred to the Venture Capitalists and founders, and the public shareholders get left with these charts …
Here's Lyft, a company that had a $25 billion valuation when it went public, yet did a little over $2 billion in revenue, while losing almost a billion dollars — with slowing revenue growth and widening losses. |
 |
|
Even though the number two in ride-sharing company (Lyft) beat the number one (Uber) to the IPO punch, setting the table for disappointment, Uber still followed through with a public offering in May. And those that bought the stock have this chart … |
 |
|
The latest casualty has been WeWork.
This is another Silicon Valley story wrapped around an existing industry (office suites), and sold as innovation. But they appear to be late the party. The IPO was pulled because investor demand was low, for a loss making commercial real estate company that's looking for a high tech stock valuation.
September 26, 2019 The drama machine on Capitol Hill and in the media continues to suck people in, and cloud their judgement on the economy and markets. Remember, earlier this month, we looked at this chart from Pew Research that explains this bifurcated view on what we hear from the media and some of Wall Street, relative to what is happening in markets and the economy. |
 |
|
The bottom line: Democrats are largely expecting a recession. Republicans are expecting a boom.
In addition to good economic fundamentals and ultra-low rates (which is designed to incentivize risk taking), this political sentiment division is adding more fuel for stocks. It's the proverbial wall of worry that tends to be constructive for bull markets. Why does it work? Because it breeds positive surprises. Meanwhile, we have just two days remaining in the third quarter. And we will soon have some earnings to evaluate. Remember, never underestimate the appetite for Wall Street and corporate America to dial down expectations when given the opportunity. They dialed down earnings estimates for Q4. We got positive surprises. Same for Q1. Same for Q2.
With that, as we head into Q3, as you might expect, estimates have been lowered – again. As ended the second quarter, Wall Street was looking for a slight decline in year-over-year earnings for Q3 — a 0.3% decline. That number has since been ratcheted down, looking for earnings contraction of -3.8%. That sets the table for positive surprises.
September 25, 2019 While the Democrats are moving forward with an impeachment inquiry, the DOJ has stated its conclusion on the phone call in question: it was diplomacy, not intelligence. When the notes from the call were released this morning, stocks went UP, bonds went down, gold went down, the VIX went down. That's a "nothing to see here" statement by the markets. Yesterday we talked about the plunge in Bitcoin. Today it was gold and silver. Gold fell more than 2% from the highs overnight. Silver was the biggest mover of the day across global financial markets, down 3%. You can see the parallels in the chart below of the performance of Bitcoin and Silver this year. Both have had huge runs over the past four to six months. So has gold. |
 |
|
As I alluded to yesterday: Are these declines over the past 24-hours, in these key stores of value, signaling a U.S./China deal in the offing?
Trump said this morning, to reporters: "it could happen sooner than you think."
September 24, 2019 The impeachment threat has been made by the Democrats for the better part of the past two years. They now have a new 'smoking gun' issue they have rallied around: a phone call with Ukraine. But as the impeachment anticipation began to build today, Trump killed the buzz by announcing that he'll release the transcripts of the alleged "treasonous" call. For our guide, the Clinton investigations took about a year, and by the time Congress officially voted to move forward with an impeachment inquiry, stocks bottomed and resumed what was already a big multi-year bull market. Despite the noise of impeachment swirling today, the big loser of the day wasn't stocks. It was Bitcoin, down as much as 19% from the highs of the day. Let's take a look at the chart … |
 |
|
Now, we've talked about the rise, fall and rise of Bitcoin over the past few years. It has had everything to do with Chinese capital flows.
On that note, let's revisit an excerpt from my June Pro Perspectives note … Remember, this first run-up had everything money moving out of China, and less to do with Silicon Valley genius/ global monetary system disruption. In late 2016, with rapid expansion of credit in China, growing non-performing loans, a soft economy and the prospects of a Trump administration that could put pressure on China trade, capital was moving aggressively out of China. That's when the government stepped UP capital controls — better policing movement of capital out of China, from transfers to foreign investment (individuals can move just $50,000 out of the country a year). Of course, resourceful Chinese still found ways to move money. Among them, buying Bitcoin. And that's when Bitcoin started to really move (from sub-$1,000). China cryptocurrency exchanges were said to account for 90% of global bitcoin trading. Capital flows were confused with Silicon Valley genius. But in September of last year China crackdown on Bitcoin – with a total ban. A few months later, Bitcoin futures launched, which gave hedge funds a liquid way to short the madness. Bitcoin topped the day the futures contract launched. And a few months later it was worth 1/6th of its value at the top. Is this time different? Is this real traction for Bitcoin, or is this just Chinese capital flows looking for a parking place, again? Likely, the latter. It's probably no coincidence that as the prospects of a 'no deal' with China have elevated in recent months, Bitcoin has again been on the move … … they [China] fight tariffs with a devaluation of the yuan. With those prospects, if you have money in China, you have been getting it out! While cryptocurrency exchanges have been banned in China, owning and buying Bitcoin in China is not banned. The Bitcoin futures market and off-exchange (peer-to-peer) trading are liquidity sources for Chinese citizens to respond to potential devaluation in the yuan. With the above in mind, this round of Bitcoin bubble may not deflate until/unless Trump makes concessions to do a deal (which seems unlikely until, at least, we get past the July Fed meeting). With the above in mind, is the move in Bitcoin today signaling a U.S./China deal in the offing?
September 23, 2019 It was just 11 days ago that the ECB announced it would restart QE, promising to buy 20 billion euros a month, indefinitely, starting in November. That plan might be scrapped before it starts. It might not be enough. This morning, a September estimate on German manufacturing data was reported. It was the weakest in seven years. That seven-year comparison has unique significance when it comes to Europe. It was mid-2012 when Europe was on the brink of cascading sovereign debt defaults. Italy and Spain were the teetering dominos. The disaster was only averted because Draghi pulled out the central bank bazooka, promising to do 'whatever it takes' to stave off a melt-down. This weak reading on current manufacturing should seal the fate for a German recession (two consecutive quarters of negative GDP growth). That would mean technical recession in the biggest economy in the euro zone. So, as I said, the ECB's new QE plan may get scrapped before it starts. Europe may need something bigger and bolder. As I suggested going into the last ECB meeting, we may see them ultimately outright buy European stocks. They need a strategy to reduce the risk premium in stocks — to drive risk-taking, investment and ultimately demand. Negative rates haven't worked in Europe, because the policies aren't forcing savers into higher risk assets — because it's not in their culture to buy stocks. With that, through the past decade of global QE, U.S. blue chip stocks (S&P 500) have outperformed European blue-chips (Stoxx 50) by eight times (eight-fold). |
 |
|
As you can see in the chart above, the Euro Stoxx 50 remains almost 40% off of the 2000 highs.
September 20, 2019 As we end the week, let's talk step back and look at the past fifty days.
On July 31, as stocks were sitting near record highs, the Fed officially changed direction on monetary policy, cutting rates (after a nearly four year tightening cycle) and stopping the shrinkage of its balance sheet. Trump complained (not enough). Stocks swung around. But by the following morning, we were back near record highs.
Then Trump escalated the trade war. Stocks dropped by 4% over just three days, and finished down 1.8% for August . What did that (the trade war escalation) accomplish? By September, the rise in the probability of a prolonged trade war, and the rising probability of it turning into something more (an ultimate path toward military war), put global central banks on full alert, and in a defensive/risk management stance. Maybe most importantly (for global financial market and economic stability), it forced the ECB to restart QE. So twenty days into September, and we now have the ECB vowing to buy 20 billion euros a month, indefinitely. And we now have a second quarter point rate cut under the belt of the Fed. We end the week with stocks up 2.5% month-to-date. Year-to-date, stocks are up 20% (better than double the long-term average). So, let's ignore the noisy status of the trade talks for a moment. We can look back to the swoon in markets late last year, and the 20% gain this year, to new record highs, and attribute it to the mistakes and repentance of global central banks (namely the Fed and the ECB). It was policy mistakes that have shaken markets ($17 trillion in negative yielding global sovereign debt), albeit these policy mistakes were due to their lack of willingness to adjust policy for the uncertainty of the trade war. Remember, as a consequence of the Fed's 'quantitative tightening' plan, the balance sheet of the three most powerful central banks in the world peaked in the third-quarter of last year. Then the ECB started what they believed to be a path to follow the Fed's normalization program, by quitting QE in December of last year. With the combination of the Fed's QT and the ECB ending QE, by the end of last month, almost a quarter of a trillion dollars was removed from the global economy. |
 |
|
But that liquidity is about to be returned, via ECB balance sheet expansion, and likely via Fed balance sheet expansion, which is already happening as you can see in this chart below … |
 |
|
|