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Markets Must Decide Which History to Believe

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(Bloomberg Opinion) -- The S&P 500 Index rose for the fifth time in six days Tuesday, gaining 4.32 percent over the period and turning positive again for the year. The rebound comes as many point out that since World War II, there hasn’t been a down period for stocks in the 12 months following a midterm election. That seems like a compelling reason to be bullish, until you realize that with just one exception, every Federal Reserve interest-rate hiking cycle — like we’re in now — has ended in a recession. 

Now, nobody is calling for a recession in coming months, but there are plenty of signs that last year’s global synchronized recovery has plateaued and is slowly turning into a global synchronized downturn. The International Monetary Fund last month cut its global outlook for the first time in two years, including its forecasts for the U.S. economy. And although one of the bright spots in the equities market has been corporate earnings, with profits again surging by greater than 20 percent in the third quarter, there are worrisome signals. Bianco Research notes that of 239 members of the S&P 500 that have posted their results, just 47 percent had revenue that exceeded forecasts, potentially making the third quarter the first since the end of 2016 not to show a beat rate above 50 percent. The reason this is an important metric is because if companies are having trouble expanding the top line, they will have even more trouble expanding the bottom line. This is all to say that no matter what happens in the midterm elections, the headwinds facing equities are getting stronger. That should result in much greater volatility, especially with Fed Chairman Jerome Powell saying last month that it may be necessary to push rates beyond “neutral” to a level that restricts economic growth. Note that the Fed has already boosted rates seven times since December 2015, and plans to do so again next month.

To be sure, at around 15 times next year’s expected earnings, the S&P 500 looks relatively cheap when you consider that the forward price-to-earnings ratio was approaching 18 this time last year. Stripping out the sky-high multiples being assigned to certain tech stocks, the multiple drops to around 13 times, which is line with an economy that is in serious trouble. This economy isn’t — or at least not at the moment. But it may be a bit overripe. “The latest data strongly supports the view that the best days in the post-2008 financial-crisis growth cycle have been seen,” Alan Ruskin, the global co-head of foreign-exchange research at Deutsche Bank AG, told Bloomberg News.

Oil is sliding, with West Texas Intermediate Crude entering a bear market on an intraday basis Tuesday by dropping more than 20 percent to $61.31 from its high last month of $76.90 on Oct. 3. The decline in global crude prices is largely credited to lessening concerns about tight supplies, with American stockpiles expanding for almost two straight months and the U.S. government granting waivers that will allow some of Iran’s biggest customers to buy oil from OPEC’s No. 3 producer for another six months, according to Bloomberg Samuel Robinson. But maybe there’s more to the story, and the drop in prices and rise in supply is connected to an economic slowdown. The case for that argument can be seen elsewhere in the commodities market. An index of non-exchange-traded industrial commodities compiled by the Economic Cycle Research Institute has dropped to its lowest level since early 2016. According to ECRI, most market observers don’t watch non-exchange-traded commodities such as rubber and animal hides; it’s a case of "out of sight, out of mind." But these commodities are closely linked to global industrial growth, and the big declines this year are a red flag. And they’re not the only warning sign: JPMorgan Chase & Co. economists wrote in a research note last week that their global PMI manufacturing output reading for October fell to its lowest level in more than two years. "As momentum swings in the manufacturing sector often are a leading edge of turns in the broader business cycle, this news challenges our view that both manufacturing and global GDP will continue to grow at an above-trend pace in the coming quarters," the economists wrote in the note.

One area of the commodities market that seems to have found a bottom is agricultural products. After falling about 20 percent between the start of March and mid-September, the Bloomberg Agriculture Subindex has rebounded about 6 percent. That seems to be enough to boost the spirits of U.S. farmers, who are the most optimistic they’ve been since any time before trade tensions with China escalated, reports Bloomberg News’s Shruti Date Singh. That’s according to a monthly agricultural economy barometer released Tuesday by Purdue University and CME Group. The measure jumped to 136 points in October from 114 a month earlier. Most notable was the rebound in future expectations to 146, about on par with the level in June. China in July slapped tariffs on a host of U.S. farm goods including soybeans. Some of the newfound optimism comes from “producers’ relatively optimistic perspectives” on prices for soybeans, a focal point in U.S.-China tensions. The growers also felt more positively about corn and wheat in the year ahead. More than 60 percent of respondents also said the U.S. trade deal with Canada and Mexico, which was announced in early October and still needs legislative approval, “at least somewhat relieved their farm-income concerns,” according to the report. The monthly economic sentiment index is based on a survey of 400 producers.

Just like stocks, junk bonds are rebounding from a nasty October sell-off that was the worst since January 2016. The Bloomberg Barclays U.S. Corporate High Yield Index has gained 0.26 percent this month through Monday after falling 1.60 percent in October. In addition, an index of credit-default swaps tied to bonds rated below investment grade has dropped to a three-week low, showing traders feel the securities are in less danger. Although there are many metrics that show U.S. companies may be over-levered, with the Institute of International Finance putting the corporate debt-to-GDP ratio at about 72 percent — just below its all-time high in early 2008 — borrowers don’t seem to be having much trouble meeting debt payments. Moody’s Investors Service said last week that the trailing 12-month default rate for U.S speculative-grade, non-financial borrowers dropped to 3.1 percent in September, the lowest since November 2015. It forecasts the rate will continue dropping, falling to 1.7 percent by mid-2019. Moody’s also said the number of companies with a rating of B3 (which marks the bottom half of it’s speculative-grade ladder) or lower and have dropped about 38 percent to 181 from the peak of 291 in April 2016. Furthermore, these borrowers account for about 11.6 percent of the total speculative-grade universe, below the long-term average of 14.9 percent. “”Taken together, the decrease in the absolute number of companies on the list, and the drop in the list’s percentage share of the overall spec-grade population, point to near-term default risk as low,” Moody’s analyst Julia Chursin wrote in a research note Monday.

Indonesia’s rupiah is having a moment. The currency has appreciated 2.70 percent this month, culminating in its biggest one-day gain since 2016 on Tuesday. Southeast Asia’s largest economy said Monday that growth held above 5 percent for a seventh straight quarter. The news came amid evidence that foreign funds have been snapping up Indonesian assets in recent weeks as faster-than-forecast growth and relatively benign inflation of about 3 percent bolstered demand. The rupiah has also been shored up by the introduction of a domestic market for non-deliverable forwards, which is aimed at reducing dollar demand in the offshore NDF market and deterring hoarding of the U.S. currency, according to Bloomberg News’s Tassia Sipahutar. “There’s a strong buying spree among foreign investors for Indonesian bonds and stocks, with many apparently realizing that the domestic fundamentals are more resilient than anticipated, particularly on government bonds,” Satria Sambijantoro, an economist at PT Bahana Sekuritas in Jakarta, told Bloomberg News. President Joko Widodo, who is seeking a second term, is boosting spending ahead of an election next year, with the economy set to be among the key voting issues. The latest growth data suggests the economy is able to withstand the shock of higher borrowing costs after the central bank raised rates by a total of 150 basis points since May to protect the currency. Those moves seem to be working.

The U.S. Treasury Department sold $27 billion of 10-year notes on Tuesday, the most ever for that maturity, as the government steps up its borrowing to pay for a bulging budget deficit. As most everyone in the markets knows, Treasury yields have backed up of late, and took a lot of the blame for the sell-off in stocks in October. The concern has been that all this new borrowing would overwhelm demand, sending yields shooting even higher and raising borrowing costs not only for the government but for companies and consumers as well, regardless of what the Fed decides to do with interest rates. But as Tuesday’s auction showed, maybe those fears are a bit unfounded. In a sign of good demand, the notes were sold at a yield of 3.209 percent, just below the 3.221 percent they were trading at in the so-called when-issued market immediately before the auction. In addition, a record 73.8 percent of the issue was sold to indirect bidders, which are generally seen as a proxy for foreign demand. These results should bode well for the Treasury’s auction on Wednesday of a record $19 billion in 30-year bonds.

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To contact the editor responsible for this story: Beth Williams at

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.

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