Bank earnings, rising mortgage rates, what strategists say about the selloff, and “dangerous undercurrents” in the global system
I am going to start putting the weekday newsletter into sections to create a flow between news items. I have six sections in todays’s newsletter: markets, macro, micro, the US, the UK, and China. So there’s a lot of news flow, most of it negative unfortunately. The key piece in the mix of all of this is the 4.2% update to the GDPNow tracker. That tells you that, despite the negative news flow, the fundamentals in the US are still on track.
My view: This downdraft will eventually pass as earnings season gets underway. The fundamentals of the US economy are still good enough to put a floor under earnings and stock prices. At the same time, the Fed’s timetable is likely to accelerate, and that will put upward pressure on interest rates, undercutting the economic cheer.
Big U.S. banks are set to report their most profitable third quarter since the financial crisis. But underneath the blockbuster numbers are reasons for caution.
Bank profits have been strong this year, thanks in large part to a December law that slashed the tax bill for banks and other corporations. But as the tax cuts become business as usual, investors and analysts have turned their attention to worrying signs about the banks’ future growth.
Analysts are projecting year-over-year profit growth of 21.4 percent for the third quarter, according to I/B/E/S data from Refinitiv, in part reflecting the sweeping tax overhaul approved by Congress late last year.
But this year’s earnings growth, estimated at 23.1 percent, is likely the peak for the profit cycle, with growth forecast to slow to 10.3 percent in 2019 as the comparison period reflects a full year of lower corporate tax rates.
Cost pressures for companies are mounting, Lori Calvasina, RBC Capital Markets head of U.S. equity strategy, wrote in a note on Tuesday, adding that more than a third of S&P 500 companies have seen full-year margin expectations shrink since June.
Calvasina said she’s been factoring in “back half deceleration” in 2018 margins and also a stronger dollar, but expects those issues have not been “fully baked into bottom up consensus estimates yet.”
Tim Ghriskey, chief investment strategist, Inverness Counsel, New York
“It’s an accumulation of various issues. Bonds began to sell off again. The prospect of higher rates concerns investors. Also, we’re in a blackout period for companies to buy their own stock, which has been a significant boost to the market. Then you have the elections coming up. The general feeling is that Democrats will win the House and Republicans will stay in control of the Senate. If Democrats were to win both houses, the stimulus we’ve gotten could be in jeopardy. That’s been an overhang.”
“There really aren’t fundamentals issues, though maybe there’s some trepidation going into earnings season that all the good is already in there and that potential issues could surface.”
Industry bellwether Bitcoin had seen its daily transaction volumes fall from an average of around 360,000 a day in late 2017 to just 230,000 in September 2018. Meanwhile, daily transaction values were down from more than $3.7 billion to less than $670 million in the same period, Juniper said in the study, The Future of Cryptocurrency: Bitcoin & Altcoin Trends & Challenges 2018-2023….
“In short, given our concerns around both the innate valuation of Bitcoin, and of the operating practices of many exchanges, we feel that the industry is on the brink of an implosion,” Juniper said.
Manipulation in cryptocurrencies is a growing concern for regulators—and even for some proponents of the digital coins. The Securities and Exchange Commission cited that risk in August when rejecting several bitcoin-based exchange-traded funds. The office of New York Attorney General Barbara D. Underwood highlighted the issue last month in a report warning that crypto exchanges were vulnerable to manipulation.
My view: The big takeaway is that the near-term prospects for the economy are still favorable. GDPNow is emblematic of this. Against that backdrop are the risks from increasing interest rates and a lot of private debt that has built up in the last cycle. The jitters we see in housing are a sign that higher US rates are starting to bite. On the IMF, concentrate less on the trade-induced economic growth forecast downgrade and look more at the worries regarding systemic vulnerability.
The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2018 is 4.2 percent on October 10, up from 4.1 percent on October 5. After this morning’s wholesale trade report from the U.S. Census Bureau and this morning’s Producer Price Index release from the U.S. Bureau of Labor Statistics, the nowcast of the contribution of inventory investment to third-quarter real GDP growth increased from 2.09 percentage points to 2.20 percentage points.
The next GDPNow update is Monday, October 15.
The International Monetary Fund said the world economy is plateauing as the lender cut its growth forecast for the first time in more than two years, blaming escalating trade tensions and stresses in emerging markets.
On the eve of its annual meetings in Bali, Indonesia, the fund on Tuesday projected a global expansion of 3.7 percent this year and next, down from the 3.9 percent projected three months ago. It was the first downgrade since July 2016.
The International Monetary Fund teases us.
It talks of “dangerous undercurrents” in the global system. It warns of a “sudden, sharp tightening in financial conditions” that could pop the asset bubble at some undefined moment in the future, without pinning down the likely mechanism…
the US does remain the global financial hegemon. China, Brazil, India, and their peers lack deep capital markets. The euro remains dysfunctional.
The global payments nexus is dollarized. So are the offshore lending markets. The Bank for International Settlements says cross-border loans in dollars outside US jurisdiction – with no direct lender-of-last resort behind them – have ballooned from $2 trillion in 2002 to $13 trillion today. This rises to $26 trillion when equivalent derivatives are included.
The world has never been more sensitive to Fed tightening or to moves in the dollar. The international system is out of kilter and extremely dangerous.
Here’s what the bond market is really telling us about the economic future.
The cost to borrow money is on the rise. That is bad news for home buyers and other prospective borrowers. It helped cause a stock market sell-off on Wednesday, and prompted President Trump to say that the Federal Reserve has “gone crazy.”
But it amounts to good news for the long-term direction of the economy.
In effect, the multi-trillion dollar global bond market is signaling a little greater confidence than it did just a few weeks ago that the nine-year expansion in the United States may have room to keep going for years to come, and without inflation taking off.
In this week’s survey, the 30-year fixed-rate mortgage jumped 19 basis points to 4.90 percent. Rates are now at their highest level since the week of April 14, 2011.
Rising rates paired with high and escalating home prices is putting downward pressure on purchase demand. While the monthly payment remains affordable due to the still low mortgage rate environment, the primary hurdle for many borrowers today is the down payment and that is the reason home sales have decreased in many high-priced markets.
Even as developers have been reshaping Manhattan’s skyline with soaring residential towers, the local new-build market has been dropping like a stone.
The number of new homes sold in Manhattan in the year to September is down 39 per cent on the same period in 2017, according to new data from real estate firm Douglas Elliman. Median sale prices fell 9 per cent over the period.
“We’re in the middle of a US housing slowdown, with Manhattan’s prime market the first and most sensitive to react,” says Jonathan Miller of Miller Samuel, a local property appraiser.
The slowdown has been most pronounced among the priciest homes, many of which are to be found in the slew of new super-slim residential skyscrapers that have sprung up along Billionaires’ Row — the area to the south of Central Park, centred around West 57th Street — and in parts of Lower Manhattan.
In western countries, beef consumption needs to fall by 90% and be replaced by five times more beans and pulses.
The research also finds that enormous changes to farming are needed to avoid destroying the planet’s ability to feed the 10 billion people expected to be on the planet in a few decades.
Food production already causes great damage to the environment, via greenhouse gases from livestock, deforestation and water shortages from farming, and vast ocean dead zonesfrom agricultural pollution. But without action, its impact will get far worse as the world population rises by 2.3 billion people by 2050 and global income triples, enabling more people to eat meat-rich western diets.
A storm that was initially forecast to arrive as a tropical storm instead amped up to furious intensity, hitting landfall just after midday near the small seaside community of Mexico Beach, 100 miles southwest of Tallahassee, with winds topping 155 miles per hour.
My view: Note the potential “Bonton Effect” at Sears, where a viable company gets liquidated because of a poor capital structure. Sears is a sick company. But, it’s the capital structure that threatens liquidation. Were that to happen, for me, that would be a definite signpost of advancing credit distress.
Also note Uber raising debt capital at an 8% yield. Why would they do this? It strikes me as odd. I see Uber as one of the prolific bubble companies. The same goes for WeWork, which why I have highlighted both.
Sears, which has been losing money for years, has $134 million in debt due on Monday. Edward Lampert, the hedge-fund manager who is Sears’s chairman, chief executive, largest shareholder and biggest creditor, could rescue the company, as he has done in the past by making the payment.
But Mr. Lampert is pushing for a broader restructuring that would include shaving more than $1 billion from Sears’s $5.5 billion debt load, selling another $1.5 billion of real estate and divesting $1.75 billion of assets, including the Kenmore appliance brand, which he has offered $400 million to buy himself.
The company, which had 866 Sears and Kmart stores as of Aug. 4, has been unprofitable for seven straight years and has closed hundreds of locations. It has proposed a restructuring plan to shrink its store base dramatically, at which point it expected to be profitable, the person said. But the banks argued the safest way for them to recoup their money was to sell all of the remaining stores and liquidate the inventory.
The set-up, however, is slightly odd. After issuing five and seven-year leveraged loans Uber is planning to sell $1.5bn of bonds with similar maturities and a similar level of secrecy. But the bonds will be placed privately, rather than offered to public markets, meaning they will be less liquid and therefore pricier for the company. Estimates put the yield on an eight-year bond at about 8 per cent, uncomfortably close to the yield on Tesla‘s 2025 bond yield following the company’s regulatory disgrace.
If a deal is completed, it would be one of the largest and more momentous deals of the past decade’s startup boom. SoftBank in January completed the biggest investment in a venture-backed startup, paying $7.7 billion for a 15% stake in Uber Technologies Inc. More than 160 private companies backed by venture capital have valuations of more than $1 billion, up from just a handful in 2010.
In eight years, New York-based WeWork has grown from a single office in Lower Manhattan to a workspace giant that rents more than 265,000 desks in 287 buildings, as of midyear. WeWork now occupies more Manhattan office space than any other company, renting 5.3 million feet there, according to real-estate-services firm Cushman & Wakefield.
Over 60% of young adults in the U.S. say the primary way they watch television now is via streaming services on the internet. By comparison, only 31% say they mostly watch via a cable or satellite subscription, and just 5% say they mainly watch with a digital antenna, according to a Pew Research Center survey…
None of these companies that are looking to own the future of television are TV networks, and only a few are telecom companies. Technology companies are mostly the ones looking to upend the traditional TV landscape through innovative distribution of video content via the internet.
My take: The gender gap on the economy is a big deal. And I believe it is inextricably linked to the gap between men and women on mid-term voting, where women are leaning heavily against the Republicans and men slightly favor them. In that context, expect the Democrats to take the house and for a nasty battle over Trump’s tax returns to go to the Supreme Court, where Brett Kavanaugh now sits. Meanwhile, the piece on Warren Mosler is interesting given the populist-inspired shift to the left in the Democratic base.
The Bloomberg Consumer Comfort Index fell for the first time in five weeks as sentiment slid among U.S. women, widening the gap with men to a record, according to data released Thursday.
The gap in sentiment between men and women widened to 19.4 points, the most in 28 years of data, as views of personal finances fell by 4.8 points among women and 1.1 point among men, according to the report.
Although a 1924 provision of the Internal Revenue Code gives certain congressional committees the right to request — and release — the tax records of even the president, it’s unlikely Trump would surrender those documents without an all-out legal battle. He has refused to release his returns since he announced he was running for president, arguing first that he was being audited and later that voters don’t care.
The GOP-led Congress has joined in keeping those records private, regularly voting down Democratic efforts to make Trump turn them over.
Forcing Trump to release his returns would not necessarily make them public, but would allow a Democratic-run congressional committee to decide whether there is information in those returns that needs to be investigated.
Several candidates in the midterm elections, and a few who have an eye on 2020, are coming out with plans that draw on his ideas—even if they’ve never heard of the man or the doctrine, known as Modern Monetary Theory, that he once promoted in early internet chat rooms.
Its main argument is that governments with their own currencies can’t go broke. They have more room to spend than is usually supposed and don’t need to collect taxes (or even borrow) to pay for it. One thing they can, and should, spend money on is a jobs guarantee—offering work to anyone who wants it.
My view: Brexit is a big clusterf%^k. Personally, I am sympathetic to the idea of severing ties to the EU. But we can see how difficult it will be to do successfully. Two things: first, I think Blair is right. Brexit is so contentious that a second referendum is a distinct possibility. Second, now is when the UK will feel the pain most acutely. In three to five years’ time, there may be a drag on GDP growth, but the issue will be moot. Getting to that point is the difficult bit.
The last bit on sick detainees shows you how difficult the migration issue has become nearly everywhere in the west. These countries are desperate to limit migration. But the flow is so great, they are engaging in human rights violations to stop the flow. It’s true in Greece. We see it in the US. And the UK has the same problem.
Theresa May will ask Cabinet for a customs union Brexit as DUP warns it could bring down her Government
The DUP, on whose votes the Government relies for its working majority, said it would vote against this month’s Budget if she did not back down.
The threat caused alarm in Downing Street, which was forced to insist Mrs May would not have to call a general election even if the Government could not get the Budget through Parliament.
Former British Prime Minister Tony Blair said there was a 50-50 chance of getting another Brexit referendum as Prime Minister Theresa May will be unlikely to secure a majority for any divorce deal in parliament.
“Whatever Brexit is on offer today is going to result in significant economic harm,” Blair, who served as prime minister from 1997 to 2007, told Reuters.
“I still believe it is possible that Brexit is stopped, I think there is no majority in parliament for any proposition that the prime minister brings back,” Blair said, adding that he wanted a second referendum.
An unprecedented snapshot of migrants held in British detention centres found more than half of the sample were either suicidal, seriously ill or victims of torture, a Guardian investigation has established.
The survey of almost 200 detainees held in seven deportation centres in England as of 31 August showed almost 56% were defined as an “adult at risk”. Such individuals are only supposed to be detained in extreme cases, suggesting that Home Office guidelines on detention have been breached.
My view: The US and China are in a serious trade and economic war. Everyone will be a loser in the end.
A Chinese intelligence official was arrested in Belgium and extradited to the United States to face espionage charges, Justice Department officials said on Wednesday, a major escalation of the Trump administration’s effort to crack down on Chinese spying.
The extradition on Tuesday of the officer, Yanjun Xu, a deputy division director in China’s main spy agency, the Ministry of State Security, is the first time that a Chinese intelligence official has been brought to the United States to be prosecuted and tried in open court. Law enforcement officials said that Mr. Xu tried to steal trade secrets from companies including GE Aviation outside Cincinnati, in Evendale, Ohio, one of the world’s top jet engine suppliers for commercial and military aircraft.
A 16-page indictment details what appears to be a dramatic international sting operation to lure Mr. Xu to what he believed was a meeting in Belgium to obtain proprietary information about jet fan blade designs from a GE Aviation employee, only to be met by Belgian authorities and put on a plane to the United States.
China has for years used spycraft and cyberattacks to steal American corporate, academic and military information to bolster its growing economic power and political influence. But apprehending an accused Chinese spy — all others charged by the United States government are still at large — is an extraordinary development and a sign of the Trump administration’s continued crackdown on the Chinese theft of trade secrets.
The yuan fell on Thursday morning after China’s central bank set its mid-price lower for the ninth day running, as it dropped to its weakest level in 19 months…
“The market is now focused on whether the US will add China to its list of currency manipulators. There are some US officials expressing concerns over the yuan’s depreciation and wondering if China wants to use a weaker yuan to offset the impact of the ongoing trade war,” he said.
Wall Street is bracing for the prospect that the U.S. uses this month’s semiannual foreign-exchange report to label China a currency manipulator, escalating the trade standoff between the two nations at a time when rising bond yields are already denting riskier assets.
The scenario is viewed as possible — though not probable — given the yuan has tumbled more than 9 percent against the dollar over the past six months, raising speculation that China has been deliberately weakening the currency. The Trump administration is concerned about the yuan’s depreciation, according to a senior Treasury official who spoke Monday on the condition of anonymity, and U.S. Treasury Secretary Steven Mnuchin is facing pressure from the White House to formally impose the designation on China for the first time since 1994.
Chinese property developers can usually count on September and October to be their “gold and silver” months for sales, but this year turned out to be different.
Not only were their sales figures grim for September, but the seven-day national holiday last week also brought at least two fangnao incidents – when homeowners protest against price cuts offered by developers to new buyers.
These protests are often directed at sales offices, with varying levels of intensity – from throwing rocks to holding banners and putting up funeral wreaths. As home ownership has remained the most important channel of investment for urban households in China in the past decade, price cuts have become increasingly unacceptable and a cause for social unrest.