I’ll post my comments in bold.
For the last few sessions the 10 year bond yield has been below the 3m yield, creating an inverted curve. This happened in late March and garnered some attention, before the curve un-inverted and got back up to about a 15bps spread in April. Some are pointing to the fact that if this inverted curve persists for a number of months, it can be a harbinger of a recession ahead. Clearly we’re not there yet, but worth watching. Treasury yields appear to be falling thanks to risk aversion trades (political tensions in Europe, trade tensions, geopolitical tensions…), as well as the Fed’s upcoming announcement on its preferred inflation gauge.
Other things to note:
- US-China trade talks seem to have gone south, at least for the moment
**The trade deal is terminal IMO. It’s a radioactive political hot-potato in the U.S. and Chinese leadership flat-out cannot afford to look weak domestically. This is a classic case of unstoppable force meets immovable object. Anyone who thinks anything will get resolved in the next week or month or even year is delusional. I think it’s very telling that the Chinese hastily set up a system for domestic companies to apply for tariff exemptions after the last round of tariff escalations. **
Food inflation is a problem in China at the moment. Many foodstuffs are seeing double digit price increases and the full effect of African Swine Fever won’t hit until the second half of this year. China had about 440,000,000 hogs and so far officially they’ve culled about 20% of that herd. By year end the real number could easily be 40%. Pork is a large source of protein in China so the typical Chinese consumer will feel the effects.
I also bring this up because the way the soy story is being spun in the U.S. Yes, soy farmers are hurting at the moment but it has nothing to do with tariffs. A typical pig eats an average of about 8lbs/day until it is at its finish weight and ~half of that is soy in China. On an annualized rate, the culling of China’s hog herd has reduced their soybean demand by ~64,000,000tons/year. For reference, in 2018 Chinese soybean imports hit ~88,000,000tons
-
This suggests the ramp up in tariffs Trump threatened will occur 1 June
**I see no reason to believe that they won’t. **
-
EU has said it will resist any efforts by the US to reduce sales of autos and auto components into the US market (this means the 180 day delay of the auto tariffs until November may not see a resolution before then, given the US-China talks are likely the priority)
**Germany in particular is in a horrible position. They’re net importers from China and there’s no reason to believe that China will suddenly open it’s markets wide for German exports. The German automotive industry directly employs 770,000 people out of a workforce of about 40,000,000. Automotive production is responsible for (at a minimum) 15% of German GDP. When you look at German exports as a whole (including autos) it’s about 40% of GDP. Germany is an export-heavy nation. Germany’s largest trade surplus… by far… is with the U.S. (~$70bil). It doesn’t take a lot more information to figure out that U.S. tariffs on European… ahem… German auto exports would devastate Germany’s economy (which was already on the edge anyways… might be in a recession already tbh, we’ll see next quarter). **
The worst news? Germany doesn’t have a choice. There is nowhere for them to pivot. The next two countries on Germany’s list of trading partners with which it has a surplus are the U.K. ($19bil) and India ($15bil). Fun fact about India: they have fewer than 1,000 miles of paved, multi-lane highway in the entire country. Good look selling cars there anytime soon.
-
the S&P is down 4.5% since Trump announced the escalation in tariffs on Chinese goods
**Correlation vs causation. Equity markets are over-valued and most of the underlying companies have taken on horrendous amounts of leverage. Trading volumes are also low. As such I believe we live in a world of “stairs up, elevator down”. **
-
median 2Q GDP growth forecasts have fallen from 2.65% at end-March, to just 2.0% now (JP Morgan just cut its forecast to 1.0% from 2.25%)
Feels about right
-
Companies seem reticent to invest in the current uncertain trade climate (business investment fell -0.9% m/m in April, and March was revised lower)
I call BS. The “trade climate” is just cover for the real underlying issue: too much debt as a result of the C-suite “extracting value”. If you’re a U.S.-based multinational and your leadership can’t figure out that investments in production need to be made in SE Asia ex-China, Mexico, and the U.S. (it’s really that simple) then it’s time to find new leadership.
-
The labor market and consumer confidence are still bright spots, with weakness mostly confined to the manufacturing sector
**I think automotive manufacturing will be a drag on manufacturing worldwide for a long, long time. In the U.S, an aging population means we’ll drive less and, ceteris paribus, replace our vehicles less often. This trend will be further exacerbated in Europe. China has insane overcapacity in its automotive sector. It’s really hard to be bullish on autos in any country right now even under rosy circumstances. Hence, manufacturing everywhere will be tied to a sinking anchor. **
-
China’s PMI data later this week (9pm Thursday) will be important for market sentiment
**I found China’s first (official) bank failure over the weekend to be an interesting harbinger. **
I don’t think the sky is falling, but there appear to be some clouds on the horizon…
I’m going to leave this with a crazy notion: this period of irrational U.S. equity valuations could last for quite a long time. Volume is scary low and right now the biggest fish in the pond in terms of flow of funds are U.S. pensions. Most states are trying to shore up their pensions in some capacity which means additional taxpayer contributions. For the most part, the majority of these contributions are going to increasing AUM (vs going directly to payouts). Basically every pension in the U.S. has to chase a 7.5% return and they keep underperforming year after year. So, what do they do? They increase their risk allocations. Many pension funds are now participating in what is basically unsecured lending to corporations so that said corporations can buy back their own stock… which the pensions already own. It’s a one-way street. For now.
To top things off, the “smart” money has not participated in recent rallies because, by their metrics, things are grossly over-valued. This active money has been pushed into credit and, rather than looking at credit through the lens of an old-school banker, these managers are treating credit like equities. They’re trying to beat a given benchmark or rate of return which is pretty easy to do in the credit world as all you have to do is overweight yield (which means you’re buying crap or long-dated crap).
If you’re an investment grade company there’s basically an unlimited pool of covenant-lite money out there for you to borrow and buy back your own stock. So, if you’re a CEO and your compensation is in some way tied to the stock price, what do you do? You do a buyback.
One final thing, and this goes to rate cuts (which are far more likely than rate hikes at this point IMO). Some of the smart money sees the coming economic malaise as an excuse for another round of QE and they basically see the same chain of events as the last time around: the chase for yield drives everything higher.
That said, I’m mostly in cash. I’ve been in bank preferreds for a long time now but many of them mature in the next year or so and I suspect most of them will get called (so I’m kind of treating those positions as cash at this point). I also have a position in a pipeline-focused CEF and I’m short Chipotle and Netflix (for kicks).
