We did not know it at the time but the midterms in the U.S. have proven to be a catalyst for change. We know that because Trump appears to have been spooked by the results despite calling the win (if one can call it that) the greatest ever victory.
The Attorney General, Sessions has gone and Kelly looks like going shortly. Mueller may have some new indictments but the barometer that Trump wishes to be judged by, the stock market, has slipped badly. And the trend appears to be a slippery slope downwards for a while yet. The winds appear to be heralding change.
So what is it that is spooking stocks? Simply put there was an air of expectation that despite all odds Trump would regain both Houses and there would be further tax cuts to stimulate the economy. Without the stimulus the stock market is vulnerable to running out of steam in 2019.
And with central banks tightening, many corporates are vulnerable. Gearing has increased over the past few years. The tax dividend was not spent on much needed capex. It went to dividends and stock buybacks to shore up stock prices. Productivity remains weak, wages remain stagnant and the tightening of monetary policies are starting to have an impact.
It appears as though the global economy peaked a few months ago and the weakening trend is in place. And if true, that won’t be good for stocks but at these new levels it will be great for bonds.
And that partly goes with the narrative of when the U.S. Congress and Senate are controlled by two parties. Of concern is the relationship between stocks and PMIs (purchasing managers’ index). These two variables are highly correlated and the PMI’s are showing a drop in demand. And that is not good for equities.
Currently, stocks are above the sustainable long run averages. And earnings per share and growth metrics are vulnerable to downgrades in 2019 as most analysts see growth slowing late 2019. The good run may just be starting to come to the end. An interesting indicator is semiconductor demand and that recently has been ringing alarm bells. Demand has fallen sharply.
Oil has also started to fall sharply just as the U.S. has imposed sanctions on Iran. Oil should be rising. Against the dollar the past 10 days looks bad, but against gold it is even worse. The gold oil ratio has risen from 14 in October to 18. And some market pundits have the ratio going to 23 with an oil price of $55.
Another indicator, the Boom-Bust Barometer which is a gauge of raw material prices versus initial jobless claims, is falling and has posted the longest losing streak since 2009. The index has been a reasonable gauge of likely recessions. Trump’s boast of making America great again through the introduction of tariffs appears to be hurting the U.S. and the global economy.
Today, however, started with a bang. Buoyed by the news from Kudlow that the U.S. and China were engaged at all levels to discuss trade, equities started well. Caterpillar, 3M, and the FAANGS started well and led the indices higher.
However, sentiment changed quickly and the zephyr of a rally rapidly expired. Falling energy prices set the cat amongst the pigeons. Boeing was weak after it appears it failed to inform Lion Air about software issues relating to its purchase of a 737. General Electric fell 8.6% after unveiling asset sale plans.
The pound soared on news of a possible agreement over Brexit.
Bond yields rallied today for a couple of reasons. The equity market was soft and the oil price was plunging. For bond investors, the lower oil prices mean inflation may be a bit weaker than forecast. The lower price also takes pressure off the Fed to hike rates. Core inflation looks to be settling and this is exciting investors. Real money bought today. Most of the purchases were in the front end of the curve.
And over in Japan, bonds responded positively as the Nikkei weakened. The 10-year JGB edged down slightly to 0.115%. Credit growth in China slowed sharply in October pointing towards a further weakening in the Chinese economy.
At some point, the lower oil prices will stress drillers and that will test the HY (high yield) indexes and owners of HY bonds and loans. Bonds of three European issuers capitulated this week, pointing to signs of mounting stress in the sector.
The iBoxx euro liquid high yield index breached 4%, a level not seen for 2-years. More HY firms are expected to default as the mix of easy cash, and tightening economic conditions will test the ability to repay debt or extend or roll loans.
Equities: The S&P fell 0.48% and the Dow fell 0.16%. The Vix closed at 20.42 while the Stoxx rose 0.7%.
Currencies: The Bloomberg Dollar Index fell 0.1% while the Euro rose 0.4%, and the yen was steady.
Bonds: The ten-year closed around at 3.14%. The 2-year closed at 2.8911% and the 30-year closed at 3.363%. The ten-year bund closed at 0.41% and the OAT closed at 0.785%. The U.S. curve closed on the day with the following closes 2/10 at 24.7 bp, 2/30 at 47.1 bp and the 10/30 closed at 22.2 bp. The U.S. 5-year closed at 2.98%.
Commodities: WTI fell 7.9%. The bear market appears to be locked in. Copper rose 0.4% and gold was steady.
Bitcoin is trading at around U$6,282.
Aussie Market Today.
The trend continues for equities. And today should be a risk off day as equities continue to stall in the U.S. Sentiment appears to be changing. And expect some news at some point on tariffs designed to try and lift markets. China needs to be watched for direction and any major announcements there will reverberate through the Asian region.
Bonds should be better bid on the day, as that was the tone from offshore.
The Aussie dollar continues to hold despite a strong dollar and commodities stalling. With an outlook that is biased towards slowing, the Aussie looks vulnerable to a fall.