Gluskin Sheff’s Dave Rosenberg is a well publicised bear on the North American economy so one shouldn’t be surprised by the tone of his recent research that argues the Fed is still in a state of denial as to the condition of the real economy, which the market continues to see in vivid colour. Take this quote for example.” If there was one development that blunts the overall dovishness (in last week’s Fed statement), it was this high level of divisiveness among FOMC officials. I would have thought that more of the hawks would have thrown in the towel and that a plurality, instead of just less than half, would be projecting some rate relief. Talk about denial,” he writes. ‘’What more evidence do they need?’’ asks Rosenberg, in a follow up note. He points to the yield curve, how defensives are leading the equity market and the fact that 10-year Treasuries have provided much better returns than the Russell 2000 this year. Rosenberg also poo poos those who reference the healthy state of the consumer, for instance. He points out that imbalances in this recession are not with consumers nor with banks, no two recessions are the same, he says. This time its the corporate sector and shadow banking, and they will need to wash out sooner or later.
With funding rates and yields on corporate debt falling, it poses an interesting question as to whether this has implications for corporate leverage. Lower funding costs should be good for credit quality, provided corporates don’t releverage to take advantage of cheap funding. CreditSights last week published they latest analysis on US corporate leverage, which provides perhaps the best read on that measure currently. The report provides analysis of gross and net leverage for US investment grade, both on a weighted average and median basis. The data set covers about 70% of the market value of the IG index. The bottom line here is that gross leverage is ticking up, with Utilities, Telecom and Media the sectors with the highest leverage. Interestingly, the increase in leverage in most marked in the most vulnerable ratings bucket, BBB, where concentration is the largest.
We’re in the third cyclical slowdown of the current economic expansion and its likely to be the broadest and deepest of them, Cornerstone Macro says on May 30. In that context, Wall Street analysts that are still predicting 11% EPS growth in 2020 need to get real. Lumber prices, seen as an ISM proxy and a favoured leading indicator at Cornerstone, are at a cyclical low. EPS estimates for 2020 will catch up with reality and fall to zero by the end of this year, they say.
The European Central Bank may hope for the best, but it is preparing for the worst. An escalating US-China trade war is of itself unlikely to snuff out global growth, but preparation for a fracture of the world trading system is being undertaken. As Mario Draghi prepares to hand over the ECB’s reins to an undecided successor, he seems to be restocking its armory, even if he is not the one who is likely to fully deploy it.
The Fed is in a double bind. The current U.S. macro picture is reasonably benign, with decent growth and stable core inflation close to the target. The labor market is extremely tight, but wage gains are under control and represent no near-term threat to inflation. But the intensifying trade war with China, the second front with Mexico, and the risk of a third front with Europe, threaten to depress growth and raise inflation.
Armed with a full year’s worth of trade data, Nomura find strong evidence of US and China import substitution in over half of the 1,981 tariffed products, in this detailed report. They estimate the gains for the world’s 50 largest economies from US and China import substitution over Q1 2018 to Q1 2019, with Vietnam the largest beneficiary, followed by Taiwan, Chile, Malaysia and Argentina. Asia (ex-China) has gained most from US import substitution, while Americas (ex-US) has benefitted most from China import substitution. Europe has not benefitted much, the report concludes.
The impact on prices of a 25% tariff on Mexican imports would be partly offset by a sharp drop in the peso. But the potential disruption to the motor vehicle industry, which relies on a continued flow of parts back and forth across the border, means that the damage to the US economy could still be significant.
In this note Absolute Strategy Research see many similarities in sentiment that were in evidence at the start of 2019 when there were highly polarised sentiment readings across assets, which was consistent with stretched levels of ‘risk off.’ However, not all the stars are aligned currently, they write in their weekly Sentiment, Positioning and Risk Essentials report. ASR measure sentiment using their proprietary Sentiment Barometer Indicators (SBIs), which use behavioural biases to create series’ that have the same dynamics as survey-based indices. These SBI indicator readings, when taken in an historical context can provide some useful guidance to investors. On Credit, US High Yield has again dropped into stretched pessimism territory versus Investment Grade, though SBI readings have yet to hit the lows seen coming into 2019, while on Rates, optimism on bonds is stretched, while implied US bond volatility was running at overbought SBI levels. However, on global equities, risk appetite indicators have yet to hit lows. Equity SBI breadth has moved onto a negative footing, but is still above past lows, and sentiment is also not yet oversold vs. Bonds. But, big equity index levels are worth watching (especially Kospi 200).
China has two big cards to defend the yuan in the form of oil and gold contracts, FFTT says on May 30. That gives Beijing the potential to “devalue oil” or break the London gold market that underpins the dollar, the piece argues. China won’t play the cards unless they have to – but yuan/dollar at 7.0 is a red line that can and will be defended and can be defended. If anything bad happens to the yuan, the London gold market, and by extension, the US dollar will end up suffering more.
It is not clear if the latest trade actions launched by the US against Mexico and India form part of coherent plan, writes Udith Sikand from Gavekal Research. Such moves do signal that the US-centered multilateral trading system is hanging by a thread, Sikand argues. This upending of the post-WWII order is especially bad news for trade-dependent emerging economies, which, as a group, have pursued a development model based upon Ricardian principles of specialization and dispersed production. For global investors, the case to invest in such markets is looking thin.