'An innocent person who wanted nothing more out of life than to love ...'
... to be loved and to be a banker." This was Newman’s excuse for speeding, to help his anguished wannabe banker friend, in a hilarious Seinfeld episode from 1992. I started an annual speaking tour to Bankers’ Associations this week in sunny Ann Arbor, Mich., where the room of welcoming bankers emitted calm in a news-filled week for the markets. While impeachment-related events dominated headlines, the market was whipsawed by contradictory reports on trade and talks between the U.S. and China. There is broad agreement a manufacturing recession is underway, with this state and its auto sector at the epicenter. This could be a problem for President Trump as his re-election hopes are counting on winning at least one of three states, including Michigan. If Democrats keep all the states that they won in 2016, they would only need to flip 38 electoral votes to take the White House. They could do so by flipping Pennsylvania, Michigan and Wisconsin, which account for 46 electoral votes combined, had a margin in favor of Trump of around 1% or less in 2016, elected a Democrat in the 2018 Senate race and have seen Trump’s net approval turn deeply negative. While we wait to see what comes out of the president’s White House meeting Friday with China’s vice premier, none of four stories raising concerns this week—Xinjiang Province officials being kept out of the U.S. because of Muslim repression, possible new investment sector restrictions, more Chinese companies blacklisted from doing business in the U.S., and Trump comments on Hong Kong protests—is likely sufficient to halt a potential positive announcement as small as a tariff-hike delay. This is low-hanging fruit and, Evercore ISI surmises, China almost certainly would be a willing participant as would Trump, whose approval rating largely has tracked the probability of a trade agreement happening.
Like watching paint that won’t dry, equity markets have remained trapped in a trading range for four months, hostage to the on-again, off-again trade discussions. It’s difficult to recall a time in which both Semiconductors and Construction (both offensive), and Utilities and Household Products (both defensive), have led in performance. S&P 500 at 2,822-2,853 represents critical downside support, with a move above 2,939-2,967 needed to confirm upside acceleration. The percentage of stocks with an upward sloping 200-day moving average is at a 22-month high, with Financials and Consumer Discretionary experiencing the biggest improvements. Investors have adopted a neutral market stance, with the biggest question whether elevated put/call ratios (the 10-day average is in the 95th percentile) and the tailwind of Q4 seasonality (the calendar tends to improve starting mid-October) will be enough to overcome the market’s continuing defensive tone. High beta vs. low beta is probing fresh lows and REITS/Staples/Utilities remain near fresh relative highs, aided by a 10-year Treasury yield bouncing around 1.50-1.60%. Yield-starved investors enjoyed Q3 dividends, which rose a very strong 13.5% quarter-over-quarter annualized and 8.2% year-over-year (y/y), putting the S&P yield at 2.01% and well above the 10-year bond yield. But it may be early to declare value’s style awakening, as it’s moving on weakness in growth, not a sudden dominance in value. As for small-cap stocks, having trailed the broader S&P by 1,300 basis points over the past year, their relative valuations are their most attractive since June 2003.
Almost all the data this week affirmed the economy is slowing, mainly due to disruptions and uncertainties related to trade (more below). Interestingly, spikes in “uncertainty” tend to be bullish for stocks. As the Q3 reporting season gets underway, the bad news is that earnings growth is expected to be weak. The good news is this is well known and the market is not far from its all-time high. Consensus earnings-per-share projections suggest a 2% decline, but assuming a typical level of beats, final results likely will be closer to a 2% increase, Credit Suisse suspects. It’s worth remembering that earnings are at record highs, so any improvement should be supportive. The bankers I met with in Michigan weren’t concerned about a recession, but bigger issues—whether the 60-40 stock/bond allocation rule of thumb is dead and implications of algorithmic trading. You know, when I was very young I was taken by a charming bank that we’d drive by on our way to the mall. I just knew I would work there when I grew up but, alas, I never became a banker. Too bad, I bet I’d have been a good one!
- The consumer can keep spending Household balance sheets are in great shape. Debt as a share of disposable income is at its lowest level since Q1 2001, and the financial obligations ratio—household debt payments to total disposable income–is hovering near 40-year lows. Through August, consumer credit was rising at a seasonally adjusted annual rate of 5.2%, accelerating from the second-quarter’s 4.6% and the first-quarter's 4.3% pace.
- Housing—from headwind to tailwind With the contract rate on 30-year fixed rate mortgages falling to 3.9%, refinancing applications jumped 9.8% last week and are up 162% over the last year. Purchase applications are running 10% above the year-ago pace. And Fannie Mae’s monthly survey shows September purchasing sentiment up 4.3% vs. last year, a positive for home sales.
- Green light for the Fed Headline and core September producer prices fell the most in more than four years, lowering the y/y headline PPI increase to 1.4%, nearly a 3-year low, and dropping the y/y core PPI below 2% again. Headline CPI was unchanged and held at 1.7% y/y, while core CPI came in at a below-consensus 0.1%. Combined with Fed balance-sheet purchases to assist the repo market, Fed Chair Powell’s dovish comments this week in Denver and the September meeting minutes, the inflation figures make an October rate cut a near certainty.
- It’s hard finding workers Even though they fell a third consecutive month in August to a 17-month low, job openings continued to exceed the number of unemployed. Small businesses say difficulties finding workers is their biggest problem, according to the National Federation of Independent Business (NFIB) monthly survey (more below). September’s drop in the jobless rate to a 50-year low showed that the rates for those with less than a high school degree and for those no longer counted in the labor force but still desiring a job were at record lows—signs of tremendous healing, which is good, but also growing tightness in the labor market.
- Mid or late cycle? The NFIB optimism index fell for the third time in four months in September and is off 6.1 points from a year ago, the biggest y/y drop since March 2009. While still elevated, optimism appears to have peaked, with respondents reflecting growing pessimism over the trade war’s negative impacts.
- Gulp, gulp and gulp!!! The Fed recently created a trade policy uncertainty gauge which, dating back to 1960, is in uncharted high territory, signaling trade is dragging down growth. The New York Fed’s Recession Probability Model sat at 38% in August—historically, a reading above 30% has been associated with recession 12 months later. Also, the OECD U.S. Composite Leading Indicator fell the most in 10 years on a y/y basis.
Hillary? According to a Trump tweet, he no longer views Biden as a challenger and the betting markets would support that. Warren is now the clear front-runner, with Hillary (!) emerging in third place according to various polls. Furthermore, PredictIt betting odds that Democrats will control the Senate after the 2020 election have spiked. RBC says a combination of a Warren White House and Democratic Congress could prove extremely challenging for Healthcare, Energy and Financial stocks, but could prove supportive of the already growing popularity of the environmental, social and corporate governance (ESG) investment approach since issues such as climate change and fair play would be in the spotlight. Interestingly, most of the sectors at high risk under a Warren presidency from a policy perspective already are deeply undervalued vs. the broader market.
Is it any wonder the progressive Dems are leading? Officially, there is record-high income inequality in the U.S. New figures show that the Gini coefficient, which measures the share of income in society that needs to be redistributed to make everyone perfectly equal (0 represents perfect equality and 1 represents maximum inequality), stands at 0.485, its highest since the Census Bureau began measuring it in 1967, when it was 0.397.
Markets shouldn’t sweat the manufacturing ISM While it came in at 47.8, a second straight monthly reading below the Maginot line of 50 between expansion and contraction, history suggests the gauge has no correlation with forward market performance until it’s 42 or lower or 60 and higher.