REALITY BITES

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Equity markets were off today. Some of the weakness was because the CPI was lower (anticipated) and the drugs are wearing off on the Tax Bill.  Markets’ reactions to Tax Bills are interesting. In the run up to the Bill being legislated, equity markets are buoyant. But once the reality of a Tax Bill actually being passed sinks in, then that optimism is shed through disappointment.

That’s exactly what we are now seeing. Equity markets are starting to ponder the reality and are reacting to how the Bill will affect their lives and business. The tax cut has been anticipated and that’s the 18% performance by the S&P 500 this year.

However, the market is following the same trajectory that occurred under Kennedy, Reagan and Bush and, that is, once signed, the initial stock rally comes to stop or slows. The exception was G.W. Bush when the second Bill in 2003 led to a rally once the Bill was written into law.

On the day, the bond market staged another rally as the equity market weakened. Inflation remains persistently weak.  However, some economists are finding a silver lining, which is interesting. Overall average weekly earnings fell 0.1% and real wages grew year on year by 0.4%. Something is clearly wrong and perhaps the PhD trying to fit the model to some trivial maths needs to think again. There is a disconnect.

If as reported, employment is not only at full employment and wages are stagnant or falling in real terms then profitability must be falling, and productivity cannot be improving. And we do see this in the numbers.

The economy has some real issues. After 85 consecutive months of economic expansion and with an economy at full employment and with some modicum of productivity improvements, inflation should be growing rapidly, and wages growth should be strong.

The problem is that asset growth has come at the expense of capex, and most of the jobs are at the margins where there is little power to demand increased wages. As we saw in NYC a while ago with movement to increase waiter’s wages from $8 an hour to $12 an hour with no tips. The experiment lasted a mere couple of weeks before restaurant owners crowed they would be out of business if the arrangement continued.

For U.S. stocks, the drag on the day came from energy and tech stocks. The Vix hit a 2-month high and closed at 14.5. The selloff on the day was generally across the board except for financials which are expected to benefit from higher rates. Utilities and consumer staples were amongst the largest decliners.

Bonds had an interesting day. The yield curve flattened and is the flattest for some 10 years. The view is that the Fed will hike short term rates, but inflation will remain subdued limiting how far longer bonds can rise in yield. As rates increase and the Fed increases short term rates, the economy will slow. That is the theory at least.

Retail sales rose unexpectedly for October by 0.2%. Some economists are pointing to this number that inflation is stirring and that the Fed should be more aggressive. Target today reported a fall in profit but an increase in sales. The real sting was that they saw the improved trading conditions weakening as we move into the holiday season. This is interesting because sales should be strengthening.

 

Recap:

Equities: The S&P 500 fell 04% and the Dow was down 0.56% while the Stoxx 600 fell 0.5%.

Currencies: The pound rose 0.1%.  The yen rose 0.3%.

Bonds: the 2-year was steady to close at 1.69The U.S. 10-year closed at 2.329 % fall of 5 bp in yield. The 30-year closed at 2.772 % in 4 bp. The curve flattened about 4-6 bp depending on the maturities. The 2/10 closed at 64, the 2/30 at 108.4 bp and the 10/30 closed at 44.2 bp. The European 10-year benchmark closes were, gilts closed at 1.28%, bunds at 0.375% and OAT’s 0.57 %.

Commodities: Gold fell 0.2% and WTI fell 0.8%.  Chinalco is said to be reducing its capacity this winter by 2 mln T of alumina capacity. Nickel was down 0.8% and zinc was flat. U.S. crude, gasoline stocks rose unexpectedly last week as output increased. The increase in inventory was 1.9 million barrels versus an expected fall of 2.2 mln barrels.

Aussie Market Today.

Bonds are likely to improve on the day. The trend from offshore is for short term rates to remain muted whereas the movement is in the longer bonds. A rally in maturities out past 5 years would not be unexpected. Investment grade credit should improve as demand for yield picks up.

Geopolitical tensions are still a concern although tensions appear to have been cowed for the moment.

Equities are likely to take the lead from the U.S. and sell.

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