Axios Markets

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April 30, 2019

1 sad thing: RIP John Singleton, an amazing talent.

1 fun thing: I'll be in Washington, D.C., on Wednesday for the annual Investment Company Institute membership meeting. (SEC Chairman Jay Clayton will be there!)

1 playoff thing: Go Nuggets!

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Situational awareness:

  • President Trump, his children and the Trump Organization are suing Deutsche Bank and Capital One to prevent them from providing financial records requested through congressional subpoenas. (USA Today)
  • A reading on Chinese manufacturing fell in April from March's reading, which was the first expansion in 4 months, suggesting China's recovery may be more delicate than previously thought. (Reuters)
  • Bridgewater Associates co-founder Ray Dalio was ranked the top earner in Institutional Investor's annual list of hedge fund managers with an estimated $2 billion in compensation. (NYT)

1 big thing: The return of synthetic CDOs

Illustration of a wall street trader's hand bursting through the ground.

Illustration: Sarah Grillo/Axios

Left for dead in the aftermath of the global financial crisis, collateralized debt obligations (CDOs), one of the most notorious agents in the collapse of the financial system, are starting to gain favor again on Wall Street.

  • Synthetic CDOs, seen as particularly risky, both for a bank's balance sheet and its reputation, also have seen a wave of fresh investment this year as investors look for ways to bet on corporate defaults and generate yield.

Details: Christopher Whittall of International Financing Review reports, "Trading volumes in synthetic collateralised debt obligations linked to credit indexes are up 40% this year, according to JP Morgan, after topping US$200bn in 2018 on the back of three years of double-digit growth. Meanwhile, analysts predict more than US$100bn in sales of bespoke synthetic CDOs in 2019 following an estimated US$80bn of issuance last year. "

What's happening: Since 2009, after the Fed began its quantitative easing program, investors have piled out of bonds and into riskier assets in an effort to replicate returns of the past. Portfolio managers have tried buying stock options, investing in hedge funds, private equity and alternatives. CDOs look to be the latest pick.

  • Whittal reports that Citigroup, which was already investing in CDOs, has hired more traders to focus on the synthetic market in recent months. Deutsche Bank and Barclays look to be increasing their presences as well.
  • "We provide solutions for our clients as there is a need in the market from investors for the yield and exposure from synthetics that is not available in other markets," a Citigroup representative who was not authorized to speak publicly on the matter tells Axios.

Yes, but: Today's synthetic CDOs are largely free from exposure to subprime mortgages, which drove much of the carnage in the crisis. Most are credit-default swaps on European and U.S. companies, and amount to bets on whether corporate defaults will increase in the near future.

  • The amount of CDOs being traded also is much smaller than it was during the crisis, and is even a few hundred million dollars below the total seen in 2011.

The bottom line: "We are still at such a low level that this is not a worry at this stage," Deutsche Bank chief economist Torsten Slok tells Axios, "but we are indeed monitoring it carefully given the role synthetic CDOs played during the crisis."

2. The changing face of America's job market

Data: USAFacts; Chart: Harry Stevens/Axios
Data: USAFacts; Chart: Harry Stevens/Axios

Total U.S. GDP grew 15.5% between 2007 and 2017, from $16.87 trillion to $19.49 trillion, and certain professions saw major growth while others shrank, a new survey of government data by USAFacts shows.

What's happening: The real estate sector became the largest industry in the country in terms of value added to GDP during that 10-year period, growing 22.1%.

  • Two industries saw their share of the GDP fall: mining, which dropped 26.7% from $366 billion to $269 billion, and construction, which fell 6.4% from $835 billion to $781 billion.

Go deeper: In addition to changes in the way Americans earn money, the survey also noted some profound shifts in American households.

  • More people are living alone.
  • A greater share of the population is divorced.
  • There are more single-parent families and households without children.

All of this is leading to a shrinking average household size, meaning fewer wage earners per household, and a smaller median household income.

  • Families and individuals in the middle 20% of income make 9% less in wages and salaries than they did in 2000.
  • That is largely being made up for by government assistance, as those families received 59% more in transfers from the government.
  • This group also paid 12% less in taxes.

3. Emerging Markets' dollar debt threatens global growth

Data: Institute of International Finance; Note: Values not adjusted for inflation; Chart: Harry Stevens/Axios
Data: Institute of International Finance; Note: Values not adjusted for inflation; Chart: Harry Stevens/Axios

The continued strength of the dollar has been a headwind for U.S. businesses and it may begin to put a major strain on economies outside of the United States.

Where it stands: The share of debt issued by emerging market countries in dollars rose to an all-time high in the first quarter, data from the Institute of International Finance shows. If the currency trend doesn't change soon, countries already struggling with weakness at home will find themselves in serious trouble when these bonds need to be repaid.

  • While risk assets from global stocks to high-yield "junk bonds" have delivered strong returns to investors so far this year, emerging market currencies, which typically rally in such an environment, have missed the party entirely.
  • MSCI's Emerging Markets Currency Index last week fell to its lowest level in more than 3 months while the dollar index rose to its highest since June 2017.

Why it matters: The weakness in EM currencies suggests the market is still worried about the global economy, despite strong and steady economic readings from the U.S. and improvement in China.

The big picture: EM's problem children, Argentina and Turkey, have seen their currencies fall by around 13% and 9% against the dollar so far this year, after record losses in 2018. Both are experiencing recessions and analysts worry that defaults in 1 or both countries are on the horizon.

  • The dollar's strength could become "a chronic source of macroeconomic instability," the IIF warns.

The bottom line: Emerging market economies now make up 60% of global growth. Their health is imperative for the world economy to continue moving forward, and the dollar's strength has been weighing on it.

4. Equity funds saw outflows the week stocks hit new record highs

Money flowed strongly into mutual funds and ETFs of all kinds except for equity funds last week. According to the most recent data from Lipper, equities saw $7.3 billion of outflows, the only asset group it tracks to see money pulled out of funds.

  • The drawdown in stocks came as the S&P 500 and Nasdaq reached new all-time highs and the U.S. saw a raft of strong economic data, including retail sales and jobless claims, as well as above-average corporate earnings results.

Why it matters: Despite the run in U.S. stocks, data shows that real money investors have been selling for most of this year. That trend continues even during what should be bouts of exuberance.

5. A lesson in social media brand management from Chase

Two tweets from Chase with the hashtag #MondayMotivation
Screenshots from Twitter; Image: Sarah Grillo/Axios

Everyone took time out of their day to dunk on Chase yesterday after the bank's social media team issued an ill-advised tweet at 1:57pm mocking people who have low account balances.

Politicians like Sen. Elizabeth Warren weighed in that taxpayers who had lost their homes, jobs and life savings had provided Chase a $25 billion bailout. Traders took aim at bad Chase bets that cost significantly more than coffee or cabs. Others just pilloried the company for "shaming" the poor.

Chase took the tweet down at 2:25 p.m. and issued another one at 2:54pm It was not well received either.