Dec 23, 2018

Axios Capital

I'm already deeply indebted to the super-smart Dion Rabouin for many of the insights driving this uncommonly markets-heavy edition of Edge. Dion will be writing a daily markets newsletter for Axios starting in early January; sign up here.

1 big thing: Powell the insouciant

Illustration: Aïda Amer/Axios

We seem to have come to the end of one of the most astonishing bull runs in stock-market history, and there's very little indication that Fed chair Jay Powell particularly cares.

  • From their low in March 2009 to their high in September of this year, stocks gained more than 280%. With dividends reinvested, the total return was 365%. That's 17.5% per year, annualized.
  • All along the way they were helped along by unprecedentedly accommodative monetary policy, along with maybe just the tiniest dash of irrational exuberance.

Now, interest rates are returning to normal, and stocks have fallen back about 15% from their highs. Valuations remain pretty healthy — the S&P 500 is trading at about 15 times earnings — and in general the stocks that have fallen the most are also the ones which had previously risen the most. Facebook, for instance, might be down 42% from its high in July, but it's still up more than 250% over the past 6 years.

The big picture: Powell is not an economist; he's a capital-markets banker. Weirdly, that makes him less concerned about markets than his predecessors with economics PhDs. Much of financial economics is based on the efficient markets hypothesis, which says that market moves convey important information. That causes central bankers to get worried when markets fall. Bankers, by contrast, are well aware that stock valuations are largely arbitrary, and realize that volatility is normal.

  • It's not healthy when stocks go smoothly and steadily upwards in the face of global geopolitical chaos, as they did for the first 18 months or so of the Trump administration.
  • Markets expect the economists at the Fed to cut rates (or at least stop raising them) whenever stocks decline by 10% or more. That, too, isn't healthy. The Fed has no mandate to boost the stock market, or to catch it when it falls — especially when the fall is simply a decline from frothy to sensible levels. (I'll have more next week on stock-market valuations.)

Axios' Courtenay Brown asked Powell this week about the way in which the market has reacted to his speeches. Previous Fed chairs took great pains to choose their words carefully, lest the markets read something into them that wasn't there. Powell's different: he doesn't care.

  • Powell didn't answer Courtenay's question, which itself spoke volumes. He knows that the current hair-trigger market will jerk up and down on virtually any news, or none. That's not his problem.
  • Dion's thought bubble: Powell speaks much more frankly and in simpler terms than Yellen or Bernanke or Greenspan. Unlike Yellen and especially Bernanke, Powell doesn't feel like he needs to go back and clean it up after he's said it and the market took things the wrong way.

The bottom line: Powell will continue to make pro-forma noises about paying attention to financial markets. But he's not going to let Dow vigilantes dictate U.S. monetary policy.

Go deeper: Why the Fed was right to hike.

2. Why markets need the Fed
Illustration: Sarah Grillo/Axios

Almost everything going on in the world is bad for the economy, writes Dion.

  • Trump is attacking the Fed and picking trade fights with China, the world's second largest economy and America's top trading partner. At the same time, China's growth is slowing, which is likely to undermine growth throughout emerging economies.
  • The EU is a mess: German and Italian economic growth is slowing, the French presidency is under siege, and the probability of a catastrophic no-deal Brexit is rising by the day.
  • Japan is near another recession, if it's not already in one.

Global central banks mostly can't come to the rescue.

  • The European Central Bank has negative interest rates, and says it's going to tighten next year. Same for Japan.

The Fed is the only central bank that could realistically help the stock market. The market goes up (like on November 28) and goes down (like on Wednesday) according to its optimism or pessimism about whether the Fed will stop raising rates.

The bottom line: A U.S. recession isn't imminent, but with all the bad news around the world, it's hard to see why U.S. stocks should be moving higher. The only bid in the market comes from whatever hope remains that Powell will ride in on a white horse to save the day. After all, that's what the Fed has generally done in the past.

3. Why the shutdown matters
Illustration: Sarah Grillo/Axios

Stocks had a dreadful week last week, partly because Washington brinkmanship over a border wall led to an unnecessary partial government shutdown.

Should markets really care whether various government agencies are open or not? Yes.

  • When you accept a full-time job, you promise to turn up and work every day; your employer promises to pay you to do so. The whole point of the arrangement is that there's certainty and stability on both sides. When the government furloughs employees, it's breaking a promise to pay them a certain amount every year. That's not a small thing. (Though after prior shutdowns employees have received back pay for the days the government was closed.)
  • Other promises by the government to pay people a certain amount every year are called "bonds," and breaking those promises is called "default." Furloughs are a form of default on government promises, and they cause valuable employees to leave.
  • Some so-called "essential" employees still need to turn up to work, on the implicit understanding that they will be paid eventually, just not for a while. These employees are essentially being forced to lend their entire paychecks to the government at zero interest. Rich people can afford to make such loans; most federal employees cannot.

The bottom line: This shutdown will see a million households, more or less, going without pay at the height of the holiday season. That's a big deal.

4. The buyback cushion
Expand chart
Data: S&P 500; Chart: Harry Stevens/Axios

The stock market decline comes despite a record level of buybacks — more than $200 billion in the last quarter alone, up some 58% from a year ago.

  • Buybacks are rising mainly because companies have been very cautious about raising their dividends. If you look at the level of dividends and buybacks combined, it tracks very closely with total corporate earnings, which have been growing impressively.
  • In 2007 and 2015, earnings fell below the amount that companies were spending on buybacks and dividends. That's no longer the case.

Why it matters: It's a lot easier for companies to reduce buybacks than it is for them to reduce dividends. If and when earnings start to decline, it should be quite easy for buybacks to fall in tandem.

Bonus: 1 cute robot
Illustration: Sarah Grillo/Axios

Happy holidays from me, and from the Cute Axios Robot, to all of you.

Go deeper: The robot illustrated a story about how the U.S. can head off a robot apocalypse and meet the challenge from China

5. The weirdly healthy primary market

Illustration: Lazaro Gamio/Axios

One oddness about the current market is that the meltdown in secondary markets seems to have had very little adverse effect on primary markets.

  • As public-equity stock valuations were tumbling this week, Altria happily wrote a $12.8 billion check to buy 35% of Juul.
  • SpaceX, meanwhile, raised $500 million at an eye-popping $30.5 billion valuation. The new round values SpaceX at a 10% premium to how much it was worth in April; there aren't many public companies that can make a similar claim.
  • Uber, Lyft, Slack, and Pinterest are all planning to raise large sums in the IPO market in early 2019; don't be surprised to see them joined by Airbnb and Palantir.

My thought bubble: Normally a market swoon of this magnitude would slam the window shut on primary deals. But all those buybacks and dividends need to get reinvested somewhere, ideally in an asset class that isn't plunging in value on a daily basis.

6. Savvy, hyperinformed ultra-brevity
Via Barclays

You've stopped reading already, haven't you?

7. Hollywood's new balance of power
Via Shonda Rhimes / Twitter
8. This week: Christmas!

The markets between Christmas and New Year.

Markets will not fall on Tuesday. Every major stock exchange around the world is closed for Christmas — and in some cases Boxing Day, too — except those in Shanghai and Japan.

  • Economic data is light too, with no big reports of note.

One thing of note: It's the Fed's birthday!

  • The Federal Reserve System was created on this day 105 years ago.
9. Building of the week: Harrods
Photo: Tony Margiocchi / Barcroft Media via Getty Images

Built in 1884 on a five-acre site from a design by Charles William Stephens, Harrods is one of the largest stores in the planet.

  • Its 1.1 million square feet of floor space welcomes some 300,000 shoppers per day at the height of the Christmas rush.
  • At night, its Italianate facade is illuminated by 12,000 light bulbs straining against the winter darkness.
  • Sunset came at 3:52pm in London last week.

Elsewhere: Nike earnings rose 30%, year-on-year, in China. Snap stock hits another all-time low. Blythe Masters is no longer CEO at her blockchain startup. Oslo is abolishing city-center parking. An improbable millennial budget.