When all eyes were focused on Kavanaugh and whether he would be appointed a Supreme Court judge, stocks jumped. The big movers on the day were the big boys and they led everyone else. The mega-cap stocks surged with both Apple and Amazon.com both up about 2%. Volumes, however, remain down with the S&P Index trading about 9% below average. The day was a green light day because the Fed’s statement gives the economy a green light and sees no major problems for the economy over the next couple of years. It’s a confirmation that the best game in town is the U.S. economy.
It seems that driving the markets ahead is the belief that tariffs will not be implemented. This was neatly summed up by Jeffrey Saut of Raymond James, “ Trump always asks for the moon and then walks back his position and declares victory.” Investors believe Trump will backtrack and all will be good.
King dollar is rallying hard because the FOMC broadcast its view that not only do they expect to tighten again this year but also there will be three more next year. The dollar surged and has swept away all before it. A strong dollar usually weighs heavily on commodities and we saw that today with declines in copper, nickel, and zinc.
Meanwhile, the squeeze on oil continues and with the mid-terms just a little over a month away U.S. gasoline prices are at a seasonal 4-year high. And for the U.S. soybean farmer, the news is not good. After having crops ravaged by flood and rain, Trump’s tariffs and China’s retaliatory tariffs have seen prices plummet. Soybeans are now at $8/bushel, the lowest prices for over a decade.
The U.S. Treasury yield curve continues its flattening advance. The flattening was led by some long end buying by real money (partly because of worries about the Italian budget leading to safe-haven demand) and weak demand in the 7-year auction. The 7-year auction went at 3.034% which is the highest yield at an auction since April 2010 (Reuters). The optics for the auction were not good. The bids tailed by 1pt which is very rare for a 7-year, and bid to cover ratio was 2.45 vs a 2.55 (average).
However, all is not lost for bonds just yet. Friday should bring a swathe of duration buyers back into the market for both month-end and quarter-end purposes. The Index is lengthening by 0.06 year and this is expected to translate into several billion of buying in 10-year equivalents. Portfolios will be extending. As stocks also had a good quarter there is an expectation that we will see a rotation out of stocks into bonds and that is anticipated to be upwards of $20 bio.
Friday also brings in the PCE inflation data (Fed’s favourite indicator) and if core PCE comes in anywhere near 0.1% then this will allow the market to rally because of expected month/quarter end buying. And yet no one seems concerned that the debt ceiling is rapidly approaching and there is hardly any discussion. Hang on folks. This could suddenly get really interesting.
Over in Europe, it’s a different story. The delays in the Italian Budget saw BTP’s (Italian bonds) weaken. The 10-year bund (German bond)/ BTP spread has moved back to 247bp and the 10-year BTP is now hovering around 2.99%. At issue was the level of Italian budget deficit to GDP. After much discussion between the various parties, an agreement has been reached that the target for next year’s budget deficit will be 2.4% to GDP. Tria, the Economy Minister, wanted 1.6%.
The Budget may, thus, be rejected by the EU and the rating agencies are likely to downgrade the bonds. The German CPI data was as expected with y/y at 2.3%. The data was skewed by rises in clothing and shows energy remains elevated. (That’s probably the main reason why Europe wants to buy Iranian oil.)
We all know that valuations are stretched and many are confused as to why equity prices are so high. So perhaps it may simply be a result of a shrinking supply of publicly-listed firms. Combine the diminishing number of possible investments and massive pools of liquidity investors are confined to what’s available and have to invest accordingly.
From January through to August this year primary listings totaled $126 bio. These issuance amounts are dwarfed by the scale of buybacks which look set to push through $1 tr. By going private, regulatory oversight diminishes, and so too the short-term investment horizon of many investors.
De-equitisation is gathering pace and especially so with low capital costs and with rates near zero. The U.S. equity pool is shrinking by 1.5% annually. In 1997, there were 7,500 firms New York-listed firms. Today there are a mere 3,600 firms. The bourses in Frankfurt and the London are not immune. The number of firms listed shrank by 20% and 45% respectively according to Indosuez.
High borrowing costs won’t bring equity listings back. Private equity firms are gobbling up many companies and these investments are being fuelled by ultra-cheap money and piles of cash the firms are sitting on. It is estimated that the sector still has some $1 tr to invest.
The changing face of business means that businesses are not reliant as much in capital. The new multinationals are less capital intensive, and this is the driver of de-equitisation. Firms like AirBnB or Facebook don’t build much infrastructure. They are reliant on others doing their work. Hence the need for capital is not so great.
Perhaps as the global wealth continues to grow and these funds are channelled into investments the risk is that inflated valuations and markets that defy gravity will continue to grow. As we are seeing, the strength in the market does not necessarily reflect any ongoing strength in business or economies.
Equities: The S&P rose 0.3% and the Dow rose 0.21%. The Stoxx rose 0.3%. The Vix closed 1241 while the Stoxx 600 Index gained 0.3%.
Currencies: The Bloomberg Dollar Index gained 0.5% while the pound fell 0.7%. The euro collapsed 0.8% and the yen slid 0.6%
Bonds: The ten-year closed around at 3.055%. The 2-year closed at 2.831% and the 30-year closed at 3.185%. A slight flattening today. The ten-year bund closed at 0.532% and the OAT closed at 0.848%. The U.S. curve closed on the day with the following closes 2/10 at 22.1 bp, 2/30 at 35.2 bp and the 10/30 closed at 12.9 bp. The U.S. 5-year closed at 2.958%.
Commodities: WTI found some bids and advanced 0.9%. Gold fell 0.9% and copper slipped 1.8%.
Bitcoin is trading around $6,695.
Aussie Market Today.
Equities are likely to stage a small recovery on the day. Commodity prices may weigh on the market. The key really is Asia. If there is support out of Asia then the ASX can see a rally. There may be some quarter end squaring so be mindful that there could be some unexpected moves.
Quarter-end balancing will hold the bond market. As the Composite index is extending, we may well see some extension trades put on as portfolios extend their duration in line with the index. There is a lot for the bond market to think about over the coming months. The interest differential between the Aussie 10-year and U.S. 10-year is now negative 32pts.
The Aussie dollar looks weak against the U.S. dollar and has the potential to slide further as rates here are expected to remain steady whilst the U.S. is likely to see a number of rate increases.
Geopolitical risks remain high.