Stocks Dare Not Wane

Can someone, to me, please explain
The reason that stocks dare not wane?
If this is to be
Then how come we see
Both silver and gold, new heights gain?

It seems like the narrative is becoming more difficult to explain these days. On the one hand, risk appetite appears to be gaining as evidenced by the ongoing rally in equity markets, the continued rebound in oil prices and the dollar’s steady decline. The rationale continues to be one where hope springs eternal for the elusive Covid vaccine and that fiscal stimulus will continue to be pumped into the global economy until said vaccine arrives driving a V-shaped recovery. Meanwhile, paying for that fiscal stimulus will be global central banks, who are printing money as quickly as possible in order to mop up all the newly issued bonds. (I would wager that the ECB will purchase at least 50% of the new EU bonds when they are finally issued.)

The potential flaw in this theory is the price behavior of haven assets, notably gold, silver and Treasuries, all of which have continued to rally right alongside risk assets. Now, it is certainly possible that the continuous flood of new money into the global economy has simply resulted in all assets rising in price, including the haven assets, but it would be a mistake to ignore the signals those haven assets are flashing. For instance, 10-year Treasury yields have fallen back below 0.60% today for the first time since establishing their historic low at 0.569% in mid-April. Historically, the message of low 10-year yields has been slow growth ahead. It seems to me that doesn’t jive very well with the V-shaped recovery story that appears to be driving equity prices. Of course, the issue here could easily be that the Fed’s purchases are simply distorting the market thus removing any signaling power from 10-year yields, but they have assured us repeatedly that is not the case. Rather, their purchases are designed to insure the opposite, that the market functions normally.

Turning to precious metals, both gold and silver have been on a tear of late, with silver really turning it on in July, rising 21%, while gold has seen steady buying and is higher by 4.3% so far this month. Granted, this could simply be part of the dollar weakness effect, where a declining dollar lifts the value of all commodities. But you cannot rule out the idea that this price movement is a signal of growing concerns over the value of all fiat currencies as central banks around the world work overtime to provide liquidity to markets.

From the perspective of the narrative, it is important to accept that this time it’s different, and that these haven asset signals are merely noise in the new world order. And maybe they are. Maybe the fact that central banks around the world have added nearly $20 trillion of liquidity to global markets without corresponding economic growth is of no real concern and will not result in consequences like rising inflation or growth in inequality. Unfortunately, the one thing that we have learned during this crisis is that central banks have a single playbook regardless of the situation…print more money. Like a man with a hammer, to whom every problem looks like a nail, central bankers see a problem and respond in one way only… turn on the presses. I certainly hope the Fed et al, know what they are doing, but the evidence is that their models are no longer reflective of reality, and that is the big problem. Any model is only as good as its data, but good data doesn’t make a bad model good, in fact it is more likely to give misinformation instead.

So, let us now turn to the market’s activities this morning to see if there is anything new under the sun. While equity markets around the world are under pressure, the losses are relatively small and arguably just a reflex response to what has been a strong run for the past several sessions. Government bonds continue to rally ever so slowly in both the US and Europe, but the truly interesting things are happening in the FX world.

To start, the euro has well and truly broken out of its range, easily taking out resistance at 1.1495 during its 0.7% climb yesterday. This morning, it has added to those gains, up another 0.4% and trading at levels last seen in October 2018. Momentum is on its side and as I mentioned yesterday, I see no real resistance until at least 1.17, meaning another 1.0%-2.0% is quite within reason. At this stage, there doesn’t need to be a narrative, just the acceptance that the current trend is strong. But yesterday saw the entire G10 space rally, led by AUD (+1.6%) and NOK (+1.3%) with the former benefitting from a serious short squeeze while the latter had oil to thank for its gains. But even the yen (+0.45% yesterday) showed real strength, despite no concern about risk.

But the real story was in the EMG space, where virtually the entire bloc was firmer, although none so impressively as BRL, which rocketed 3.1% during the day. It seems that a combination of general positivity from the EU’s announced deal and the specifics of the introduction of the long-awaited new tax reform by the Bolsonaro administration were enough to get the juices flowing. Technically, it appears that barring any significant negative news, this could continue until USDBRL tests 5.00, or even the 4.85 lows seen in mid-June.

But the entire EMG bloc was on fire, with the CE4 far outperforming the euro (CZK +1.95%, HUF +1.90%, PLN +1.6%) but also strength elsewhere in LATAM (CLP +1.75%, COP +0.75%). In fact, APAC currencies were the laggards, although most of them did rise modestly. This morning’s price action has been a bit more muted, although we have seen IDR (+0.6%) halt what has been an impressive weakening trend. It seems that a local company is planning to move into Covid vaccine trials next month which has encouraged optimists to believe the second wave of infections there may be addressed soon.

Arguably, the one truly interesting thing today is the weakness in CNY (-0.2%) which seems to be a response to the story that the US has closed the Chinese consulate in Houston. The Chinese are now threatening to close the US consulate in Wuhan (who would want to work in that office anyway?) with the real concern that the ongoing cold war between the two nations shows no signs of abating. In fact, if you want a rationale for owning haven assets, this situation offers plenty of scope.

Turning to the data today, we get our first from the US in the form of Existing Home Sales (exp 4.75M) which would represent a 21% gain from last month. Of course, the level remains far below the pre-Covid situation where 5.5M was the norm for more than 5 years. The Fed remains in its quiet period as the market will eventually turn their attention to next Wednesday’s meeting, but for now, the market doesn’t need any further impetus. The story is the dollar is falling and risk is to be acquired. While the latter idea might be a little bit of a concern, the former, a weaker dollar, seems a fait accompli for now.

Good luck and stay safe


Values Debase

It used to be bonds were so boring
That talk induced yawning and snoring
But Covid-19
Is now on the scene
And bonds are the asset that’s soaring

Meanwhile in the equity space
Investors are having a race
To see who has sold
Their stocks and bought gold
As equity values debase

It’s important to understand that Covid-19 is not the cause of the current hysteria in financial markets, it is merely the catalyst that revealed the underlying problems. Arguably, the most critical of these problems, excess leverage, has been building since the financial crisis response in 2009. In fact, it was an explicit part of the response package, cut rates to zero to encourage more borrowing. The unseen, at the time, problem with this strategy, however, is that the vicious cycle virtuous circle that resulted, where investors chasing yield moved up the risk ladder thus encouraging the issuance of more and more risky securities, seems to be reaching its denouement. Welcome to today’s volatility!

Briefly, financialization of the economy has been growing aggressively since the financial crisis. This is the process whereby the corporate sector spends more time and money on managing the balance sheet than on delivering products or services. Thus, banking and financial services grow relative to total economic output. In essence, we produce less stuff but pay more for it. And yes, that is the definition of inflation, which is exactly what we have seen in financial markets. It has just not (yet) appeared in measured inflation indices, as they don’t include stock prices. Financialization has manifested itself in the massive equity repurchase programs, funded by record-breaking issuance of corporate debt, which has been instrumental in driving equity markets to record highs. But when more money is spent on equity repurchase than on R&D, it bodes ill for the longer term. Perhaps Covid-19 is the catalyst that will help us understand the long term has arrived.

As the global economy now is trying to address both a supply and demand shock to the system simultaneously, investors have collectively decided that risk is not as tasty as it was just a few weeks ago. And while many have warned that when this market turned, it would be dramatic, I don’t believe the type of movements possible were well understood. I’m guessing they are a little better understood today.

This process has further to run, regardless of what the central banks or government leaders do or say. Markets that have rallied for ten years do not correct in ten days. It will take much longer and there will be many unforeseen movements by different asset classes going forward.

In fact, the dollar is going to be quite interesting throughout this process. I maintain that its current decline is entirely a result of the market repricing the US rate outlook. Futures markets are currently pricing in another 50bp rate cut by the Fed a week from Wednesday, with a further 37bps by the end of the summer. That is significantly more cutting than is being priced for the ECB (just 10bps) and the BOJ (also 10bps). In other words, as interest rate spreads between the dollar and other G10 economies compress, it is no surprise to see the dollar decline. In fact, this was the genesis of my views at the beginning of the year and what underpinned my calls for the euro to trade to 1.17, the yen to 95 and the pound to 1.40. Of course, I didn’t anticipate anything like this, rather a much more gradual approach.

However, the dollar is also still seen as one of the safest places to be, with Treasury bonds the ultimate safe haven today and one needs dollars to buy Treasuries. The rally in the bond market has been extraordinary with the 10-year falling another 15bps today to yet another new record low. It actually traded below 0.70% briefly this morning but sits at 0.76% as I type. And that is true across the Treasury curve. While other bond markets globally have seen rates decline, nothing has matched the Treasury performance. (And for those of you who did not understand how Greek 10-year yields could trade below US yields, that is no longer the case!)

Meanwhile, havens like the yen (+0.9% today, +6.1% in the past two weeks) and CHF (+1.05% today, 4.9% in two weeks) are the stars of the FX markets. In fact, this bout of risk aversion is beginning to approach what we saw in 2008 and 2009. Today, the dollar is the total underperformer in the G10 space, but that is not the case in the EMG space. There, MXN is the disaster du jour, down 2.1% as it is impacted by the collapse in oil prices, the uptick in coronavirus cases and its reliance on the US, which appears to be heading toward much slower growth, if not a recession. But BRL is lower by 1.0%, and we are seeing most of the APAC and LATAM currencies falling this morning. CE4 currencies are benefitting from their proximity to the euro, but I expect that will change as time passes.

Into all this excitement, we bring this morning’s payroll report with the following expectations:

Nonfarm Payrolls 175K
Private Payrolls 160K
Manufacturing Payrolls -3K
Unemployment Rate 3.6%
Average Hourly Earnings 0.3% (3.0% y/Y)
Average Weekly Hours 34.3
Participation Rate 63.4%
Trade Balance -$46.1B

Source: Bloomberg

The thing is, all this took place before Covid-19, so all it can do is give us a final benchmark as to how things were prior to the virus spreading. If we get a bad number, that will be a real problem.

It is hard to overstate just how fragile this market is right now, with liquidity significantly impaired, bid-ask spreads widening and options volatilities rising sharply. Patience is a true virtue in these conditions and leaving orders at levels can be very effective. I maintain that the dollar’s weakness will not be a permanent feature, but rather a transient situation until the rate situation stabilizes. So, receivables hedgers, leave orders to layer into your strategies, it will pay off over time.

Good luck and good weekend

Virus Malaise

It seemed, for a couple of days
That the stock market’s virus malaise
Had finally broken
But now, not unspoken,
Concerns grow in multiple ways

The upshot is risk’s in retreat
And currencies cannot compete
With strength in the greenback
Which this week’s been on track
For, every prediction, to beat

As we head into another weekend, investors and traders have once again demonstrated concern over a shock change in the Covid-19 story and correspondingly have reduced their risk holdings in most markets. While the Chinese government continues to try to pump massive amounts of stimulus into their economy, the actual results may not be as impressive as the numbers suggest. For example, last night the PBOC released their Money supply data, granted a number that has lost much of its luster over the years, but one which still helps explain what is happening in the monetary system there. After all, without a robust monetary system, real economic growth is virtually impossible. And M1, the narrow measure, registered “growth” of 0.0% in January, which means it was at the same level as January 2019. That was a shockingly low outcome (forecasts were for 4.5% growth) and likely indicative of just how little economic activity is occurring in China right now. The other nasty data point was auto sales, which fell, wait for it, 92% in the first half of February. Remember, China is the world’s largest auto market, with annual sales having approached 25 million in 2017, although that number slipped to 21.5 million last year. But a 92% decline, if it persists for another month only, implies that sales will fall below 20 million, and if things don’t get better soon, that number can be much lower. The point is regardless of how much stimulus the Chinese government pumps into the economy, if people remain quarantined and cannot go out and spend it, the economy is going to suffer for a long time.

On top of the Chinese data, the other growing fear is that Covid-19 is starting to spread more widely outside of China. To date, the bulk of the infections have been in Hubei province, although the entire nation is on alert. But last night we heard of more infections in both South Korea and Japan, while the death toll continues to climb alongside the overall infection count. And for the 3rd time this month, the Chinese changed the way they count infections, which pretty much guarantees that whatever numbers they release are hogwash. I fear the virus is much more widespread than publicized, and that it will take far longer than another month for things to return to any semblance of normal in China. There is no ‘V’ shaped recovery coming in Q2, I don’t even think there is a ‘U’ shaped one on the horizon. I fear the Chinese recovery, at least for 2020, may well be ‘L’ shaped.

So, with those cheerful thoughts in mind, let’s look at markets and what they have done both overnight, and all week. Starting with equity markets, last night saw weakness in Asia (Nikkei -0.4%, Hang Seng -1.1%, KOSPI -1.5%) which took their weekly losses to -1.3%, -1.8% and -3.6% respectively. Shanghai, on the other hand, was slightly positive overnight (+0.3%) taking its weekly advance to 4.2%. Of course, Shanghai is the epicenter of a massive inflow of liquidity, so while the real economy may be cratering, new monetary stimulus can easily find its way into the stock market as people trade from home.

European markets have fared somewhat better, with the DAX (0.0%, -0.6% this week), CAC (-0.1%, -0.3%) and FTSE 100 (-0.2%, +0.2%) all biding their time as none of these countries have yet been severely impacted by the virus directly, although obviously, exports to China will have suffered greatly. Meanwhile, in the US, leading up to today’s session, the DJIA has fallen 1.1% this week and the S&P 500 is -0.2%, although the NASDAQ is actually higher by 0.25%. That said, futures markets in all three are pointing lower this morning.

Other key risk indicators are also showing significant gains this week, notably gold (+0.9% today, +3.2% this week) and Treasury bonds, where the 10-year yield is at 1.49% (-2.5bps this morning and 9bps this week).

Finally there is the dollar, which has outperformed virtually every currency this week, with only the Swiss franc even breaking even. In the rest of the G10 space, the yen is the week’s big loser, having fallen 2.0%, a true blow to its status as a safe haven. As I wrote yesterday, it appears that Japanese exporters have stepped away from the market, while leading up to fiscal year end in Japan, there has been an increase in outward investment on an unhedged basis, meaning Japanese lifers and pension funds are buying dollars to buy USD assets and unconcerned about the dollar falling. But both AUD (-1.6%) and NZD (-1.9%) also had a rough week, as the fact that China seems to have come to a virtual standstill will have an immediate negative impact on both those economies.

In the EMG bloc, LATAM currencies have been under the most pressure this week, with BRL (-2.5%), CLP (-2.35%) and MXN (-2.3%) all feeling the impacts of slowing growth in China as the first two are reliant on exports to China for a significant amount of economic activity, while Mexico, which has been holding up extremely well until this week, seems to be feeling the pain of overly extended carry positions amid a risk reduction period. MXN futures are the largest outstanding long positions on the IMM, as many investors seek to earn the 500bps of positive carry. However, as can be seen from the movement just yesterday and today, all that carry can be offset in the blink of an eye when things turn. Given how large the long MXN positions still are, do not be surprised to see the peso weaken much further going forward.

Away from LATAM, it can be no surprise that KRW (-2.1% this week) and THB (-1.6% this week) are also under pressure as the direct Covid-19 impact is greatest in those nations that do the most business with China. And not to be outdone, CNY (-0.65% this week) is trading well back through the 7.00 level and seems unlikely to reverse course until we get unequivocally better news regarding Covid-19.

On the data front, yesterday’s Philly Fed number was spectacular, 36.7 vs. 11.0 forecast, indicating that the US growth story has not yet felt any real effects of the virus. Overnight saw weakness in Australian and Japanese PMI data, again no real surprise, but better than expected results out of Europe and the UK. It seems that the signing of the phase one trade deal was seen as quite a positive, and while Eurozone (and German and French) Manufacturing all remain in contraction with PMI’s below 50.0, the levels have rebounded significantly from their low prints several months ago. This morning brings the US PMI (exp 51.5 for Manufacturing, 53.4 for Services) although this market is far more focused on next week’s ISM data. We also see Existing Home Sales (5.44M) which continue to perform well given the combination of incredibly low Unemployment and incredibly low mortgage rates.

On the day, the dollar is more mixed, having ceded some of its weekly gains vs. the euro and pound, but sentiment appears to continue to point to further risk reduction and further dollar strength as the week comes to a close.

Good luck