Market Comment June 2018

[admin]

Good primer on US debt and deficits:

The U.S. national debt is once again raising alarm bells. Federal borrowing from outside investors expanded rapidly over the past decade, totaling more than $15 trillion in 2018, and it is projected to grow even faster over the next ten years under current law. Major budget legislation signed by President Donald J. Trump, along with continued growth in entitlements and higher interest rates, will see the debt nearly double by 2028 [PDF], coming close to the size of the entire U.S. economy.

The National Debt Dilemma | Council on Foreign Relations

No pay rises, despite 3.8% unemployment. It's good for investors as it keeps corporate profits up and the Fed happy, but how can it be?

[E]xecutives of big U.S. companies suggest that the days of most people getting a pay raise are over …. [In] rare, candid and bracing talk from executives atop corporate America, made at a conference Thursday at the Dallas Fed[, t]he message [wa]s that Americans should stop waiting for across-the-board pay hikes coinciding with higher corporate profit …. to cash in, workers will need to shift to higher-skilled jobs that command more income. ….The moderator asked the panel whether there would be broad-based wage gains again. “It’s just not going to happen,” [Troy] Taylor, [CEO of the Coke franchise for Florida,] said. The gains would go mostly to technically-skilled employees, he said. As for a general raise? “Absolutely not in my business,” he said.

More Evidence of Increasing Deflationary Pressure on Wages | naked capitalism

[admin]

There is something to be said for this:

Billionaire Leon Cooperman believes that no stock or sector is off limits when he's looking for investing. In fact, he says, he'd buy any stock or bond at the right price. While the chairman and CEO of Omega Advisors says there's no secret sauce, he points to one thing as crucial: free cash flow. "Free cash flow gives companies the luxury to do good things, whether it's pay dividends, buy back stock, invest in new plant equipment, et cetera," he said.

Wall Street legend Leon Cooperman reveals investing tips

And Soros on the Italian crisis:

if the coalition introduced any innovation that could be seen as a parallel currency, it would trigger a run on government bonds and a flight of deposits from Italian banks. But there are reasonable complaints as to the way the euro area is being managed.

If the EU punishes Italy, it will reap the whirlwind | George Soros | Opinion | The Guardian

Indeed, we saw that happening last week, but the room for policy experiment is very small, debt/GDP hasn't budged even during the last years with the economy growing, record low interest rates and the ECB bond buying. Imagine what a recession does, or policy mistakes, which are likely with an inexperienced government that basically consists of fairly extreme left and right parties.

[admin]

Not good, this..

THE Bank of Italy’s debts to eurozone central banks rocketed to an all-time high of €465bn (£408bn) in May as anti-euro insurgent parties prepared to take power, a clear sign that foreign investors have begun to pull large sums of money out of the country. The institution’s Target2 liabilities within the European Central Bank’s payment nexus jumped by €39bn in a single month. This was almost certainly precipitated by the shock decision of the alt-Left Five Star Movement and hard-Right Lega nationalists to forge a coalition, armed with a subversive “minibot” parallel currency.

Capital flight from Italy surges, pushing Target2 imbalances to danger level

See our article about Target 2 imbalances here

[admin]

Trade tensions are already impacting the markets:

"It is a broad consensus across academia, business leaders and market practitioners that trade wars and protectionism are a lose-lose economic proposition," Kolanovic said. "Trade tensions continue to inflict damage to investor psychology and business confidence." But Kolanovic has taken matters a step further and quantified the negative impact Trump's trade bluster will have if the president maintains his current path — and the results aren't pretty. He estimates that US equities have already absorbed a 4.5% hit — give or take 1%. Applying that to current market capitalization, Kolanovic says this translates to $1.25 trillion of "value destruction" for US firms. For context, that's roughly two-thirds of the positive impact of fiscal measures. JPMorgan "A negotiation that includes bluffing/threats can be successful in a two-party negotiation setup, but is more likely to deliver self-defeating results in a complex system such as global trade," said Kolanovic.

Trump’s trade war market cost calculated by JPMorgan's Marko Kolanovic - Business Insider

First Argentina, then Turkey, Brazil next?

"Higher oil prices + rising interest rates + appreciating dollar, the trifecta that continues in markets today (albeit not in an extreme fashion), tends to test the ‘self insurance’ of several EMergingMarkets, together with their economic policy responsiveness," he said.

El-Erian Warns Brazil May Be Next Emerging-Market Domino to Fall - Bloomberg

If current conditions persist, corporations are likely this year to inject more than $2.5 trillion into what UBS strategists term "flow" — the combination of share buybacks, dividends, and mergers and acquisitions activity. The development comes as companies find themselves awash in cash, thanks primarily to years of stashing away profits plus the benefits of a $1.5 trillion tax break this year that slashed corporate rates and encouraged firms to bring back money idling overseas.

Companies to pour $2.5 trillion into buybacks, dividends, M&A in 2018

[admin]

Some ideas, although they seem to cancel eachother out:

Yet the recovery still has much more to run, according to Chief Investment Officer Espen Westeren. U.S. shale production has made a spectacular come-back, but is capped by insufficient pipeline capacity. And we’re only now starting to see the negative impact on global output of oil companies’ dramatic spending cuts from 2014 to 2017, Westeren said.

Hedge Fund With 69% Return Sees More to Come From Oil Recovery - Bloomberg

Southwest Airlines Co (LUV.N) shares could be poised to climb sharply after a series of setbacks hit the stock harder than that of other major airlines this year, Barron’s reports.

Southwest Airlines shares could recover from recent descent: Barron's | Reuters

[admin]

Good article describing the folly of the trade warriors:

But before evaluating the policy prescriptions for this problem, we must first consider the starting point, which is flawed. The current $370 billion deficit estimate does not account for value-added. When looking at the value-added content of Chinese exports, the U.S. deficit with China is actually only half of what it seems. And if we then add back the U.S. surplus in "invisibles" and how much money the United States brings back from investments in China, the U.S.–China deficit shrinks from 2 percent of U.S. GDP to 0.8 percent, a report from Oxford Economics revealed.

In the case of the Apple iPhone, this means that China's exports balance accounts for the full $500 iPhone value, when China adds only approximately $15 to $30 of the value to the phone. Most of the iPhone value accretes to Samsung in Korea ($150) and to Apple — the brand owner and engineer. This highlights how the normal accounting of trade flows is inherently distorted under the current trade-deficit estimates. So maybe the deck has only 25 not 52 cards.

The iPhone example also points to an area of weakness in the president's policy prescription: If the United States introduces tariffs on China's high-tech goods, U.S. companies and consumers could indirectly end up footing part of the bill. This is because the high-tech industries that Trump's tariffs are focused on is where Chinese value-added has the lowest share. If Trump were really interested in impacting the true trade imbalance and not just the misleading headline estimate, he would introduce tariffs on those sectors where China's value-added is highest. This would include sectors like textiles, where 75 percent of value-added is really "made in China."

Why China “holds all the aces” in a full-blown US-China trade war

[admin]

No, the Europeans aren't buying all that many Treasuries anymore, and the consequences could be significant:

Yet beneath the surface of the world economy, vast capital flows through fixed income markets have commanded far less scrutiny – despite far-reaching implications. A large liquidity squeeze looms, with equally large potential consequences. Cross-border bond purchases by fixed income investors could plausibly drop by more than half this year and next, to an average of only $500bn a year, versus the 2017 tally of $1.2tn. A shift of this scale, if realised, will exacerbate existing upward pressures on global bond yields to an extent greater than markets presently anticipate, with the US bond market – and the dollar – particularly vulnerable.

European recovery is bad news for the world's bond prices | FT Alphaville

[admin]

Might become relevant again..

He added: "This raises a key question for investors: which sectors and stocks are likely to produce the highest risk-adjusted returns in a market with below-average returns and elevated volatility?" The answer to this question lies in stocks with a high Sharpe ratio, Kostin said. The ratio, developed by the economist William Sharpe in the 1960s, is designed to help investors identify stocks with the best risk-adjusted returns. Goldman's High Sharpe Ratio basket includes stocks that have the highest ratios in every S&P 500 sector, which should deliver the best risk-adjusted returns even with higher volatility. It factors in consensus forecasts and the volatility implied by options prices. Kostin said the basket of stocks had underperformed the S&P 500 year-to-date by 2 percentage points but had generated an average six-month excess return of 334 basis points since 1999. "The basket performs best alongside above-average volatility, generating an average excess return of 559 bp in periods with realized volatility greater than 15 vs. 120 bp when realized volatility measures less than 15," Kostin said. A recent iteration of the basket included stocks that outperformed the market when absolute and relative volatility were low, like in 2017. But with volatility rising, Goldman has added nearly 40 new stocks to the basket, which are concentrated in the biotech, semiconductors, tech hardware, capital goods, food beverage, and tobacco industries. Some of the new stocks are:

Goldman's stock market recommendation as volatility rises on trade war - Business Insider