Feb 25, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness:

  • Shadow Mountain High School captured the girls' 4A Arizona state basketball championship, 54-31, led by star junior point guard Senya Rabouin. (AZCentral)
  • Barrick Gold said that it approached Newmont Mining for an all-stock takeover deal, months after both companies announced mega-deals in the gold mining industry. (CNBC)
  • Peloton picked Goldman Sachs and JPMorgan to lead its IPO that could value the company at as much as $8 billion. (Bloomberg)
  • Warren Buffett said Berkshire Hathaway "overpaid" for Kraft, but does not have plans to sell his stake. (CNBC)
1. It's the inflation, stupid

Illustration: Lazaro Gamio/Axios

The absence of inflation is forcing a wide-ranging rethink of long-held economic assumptions.

Driving the news: In his annual letter to shareholders, Warren Buffett admits that though he regularly preached "doom because of government budget deficits" he is no longer in that camp.

  • Former IMF chief economist Olivier Blanchard argued in a speech that for countries like the U.S., high public debt isn't necessarily a problem.

As the New York Times' Neil Irwin points out, politicians also are quickly joining the deficits-don't-matter club.

  • Rep. Alexandria Ocasio-Cortez (D-N.Y.) recently indicated openness to "modern monetary theory," the idea that deficits don't matter for countries that can print their own money.
  • President Trump did not once mention the debt or budget deficits in this year's State of the Union address, nor did he mention it last year, despite expected annual shortfalls over $1 trillion.

What's happening: The debt has not mattered largely because inflation has been absent from the economic equation.

It's inflation that raises capital and labor costs for businesses, reduces available capital for investment and clogs government balance sheets, forcing other expenditures to be capped or scrapped. But over the past decade or so, inflation has been a nonfactor, even after back-to-back years of above trend growth and government spending binges.

  • Economists have argued about the reasons, pointing at everything from the internet to the lack of unions to globalization to the way companies have invested their profits. But the end result remains the same.

What they're saying: "We've got inflation well under control here, and we don't need to be pre-emptive trying to control inflation going forward," St. Louis Fed President James Bullard said Friday.

In an interview the same day, Bullard elaborated, saying there has been a breakdown in the "Phillips curve," or the relationship between unemployment and inflation. "That's got people backing off the idea that there’s such a lockstep relationship between the real economy and inflation," Bullard said.

Further, officials at the Federal Reserve now are reconsidering the 2% inflation target that has been in effect since 2012.

Other central banks also are moving away from raising rates or slowing down stimulus as inflation has globally gone missing in developed markets like the Japan and Europe as well.

But, but, but: The ongoing crisis in Venezuela has shown that too much money chasing too few goods can still create problems. President Nicolás Maduro's money printing has led to an expected 10,000,000% inflation this year, undermining any attempts to stabilize the country's currency or its economy.

2. Banks keep winning

U.S. banks raked in a record $236.7 billion in profits last year. Even without the boost from the corporate tax cut, banks would have still made more money than ever before, according to the FDIC's latest report.

There's more good news for the banking industry, Axios' Courtenay Brown writes.

  • There were zero bank failures in 2018, which hasn't happened since 2006.
  • The average rate of loans more than 90 days late fell below 1% last quarter — the lowest level since 2007.
  • "Regulatory capital and liquidity ratios of key financial institutions, especially large banks, are at historically high levels," the Fed noted in its monetary policy report to Congress on Friday.

The good times are also playing out in the stock market.

  • Goldman Sachs, despite the 1MDB scandal, is on track for its best quarter in 3 years and the stock's surge is responsible for 7% of the Dow's 16% rebound since the beginning of 2019, per the Wall Street Journal. (Though, the stock remains down more than 25% since this time last year, after a horrendous 2018.)
  • The KBW — an ETF that tracks the big banks and regionals — has risen 17% this year.

Still, the FDIC issued a stark warning about how long the good times can last. FDIC chair Jelena McWilliams said the lack of bank failures last year is not "the new normal."

"We need to be thinking about what may be around the corner and looking for risks, even if we don't have indications [of bank stresses] now."
— FDIC chair Jelena McWilliams to reporters last week, according to the Financial Times
3. Goldman: Earnings recession ≠ economic recession

With Wall Street analysts anticipating a possible earnings recession in 2019, Goldman Sachs' economic research team estimates that this could, but is unlikely to, lead to an actual recession.

Why it matters: The forecast 10% decline in profits lowers GDP growth by 0.6 percentage points, Goldman's analysts note, and if earnings growth were to slow to 15 percentage points it could knock a full 1% off of first quarter GDP, now projected to slow from 2018's pace.

But, but, but: Analysts listed 4 key reasons not to expect a recession this year:

  • Historical correlation between earnings and economic recessions is not very tight — 13 of the 22 S&P 500 earnings recessions were not followed by a recession within 2 years.
  • Lower corporate tax rates contributed nearly half of the roughly 20% growth in S&P 500 earnings in 2018. Much of the profit slowdown reflects the well-anticipated fading of this one-off factor, with minimal growth effects.
  • The Fed's U-turn on raising rates has unwound much of the financial conditions tightening seen in the fourth quarter.
  • The impact of higher labor costs will be offset in part by cheaper oil. Faster wage growth statistically raises capex growth as firms substitute capital for labor. Cheaper oil and higher wages should also support consumption.

"Weaker profit growth is likely to weigh somewhat further on economic activity but does not indicate an impending economic recession," Jan Hatzius, and Goldman's research team said in a note to clients.

4. Huawei aims to challenge Samsung with $2,600 5G folding phone
Expand chart
Data: IDC; Chart: Andrew Witherspoon/Axios

China’s Huawei unveiled the Mate X, a $2,600 5G folding-screen phone, on Sunday at the Mobile World Congress in Barcelona, challenging Samsung's new bendable device and the consumer threshold of pricey mobile phones, the Associated Press reports.

The big picture: Huawei is pushing premium products in Europe and at home in China as it remains unlikely that their phones will be sold in U.S. anytime soon due to trade and security concerns. China is the largest country market for smartphone consumption, accounting for roughly one third of global shipments.

"Even without the U.S. market we will be number one in the world," Richard Yu, Huawei's consumer division chief, said in late January. "I believe at the earliest this year, and next year at the latest."

  • The U.S. has banned Huawei, but it has been feverishly growing in Europe, and as Axios' Bill Bishop noted on Friday, the U.K., Germany and India have balked at the Trump administration's demands to not incorporate Huawei into their respective 5G expansions.

Bonus: CNBC reports that when asked if dropping the criminal charges against Huawei would be part of the deal during the Oval Office meeting with Chinese Vice Premier Liu He, Trump said he'll be discussing the issue with U.S. attorneys and the attorney general in the coming weeks.

  • A resolution in the trade war — or even an elongated truce — could mean Huawei gets reintroduced to the American market.

Go deeper: The Galaxy Fold pushes smartphone prices to new heights

5. On to the next trade war

President Trump announced on Sunday a delay in increasing tariffs on Chinese goods to 25% on March 2 thanks to "productive" trade talks between the two nations. He also announced that he and Chinese President Xi Jinping would meet to seal a deal if progress continued.

The big picture: While the delay should provide a jolt to stocks this morning, it's the exact resolution, or lack thereof, investors have been expecting for some time.

  • "Investors have been confident that a deal would be struck and other factors are helping the stock market recover from the sell-off," Marc Chandler, chief market strategist at Bannockburn Global Forex, wrote Sunday morning before the trade deal was announced.

Similar expectations last week had been expressed in research from Bank of America Merrill Lynch, Morgan Stanley, Deutsche Bank and a host of others.

Be smart: Rather than quit while they're ahead, Chandler expects the administration's focus will now simply shift toward Europe and Japan.

  • "The Trump Administration places emphasis on economic rivalry, and from that perspective, Europe and Japan challenge U.S. national interest as much as China."

The Americans' next moves have been laid out by Trump's other foreign policy decisions:

  • Unilaterally withdrawing from the Iran nuclear treaty and threatening to punish those who violate the embargo. 
  • Insisting that allies ban Huawei systems. 
  • Wanting other nations to recognize Guaido as leader of Venezuela, despite reluctance from some allies, including Mexico.

"The U.S. is demanding others follow it in three issues in relatively quick succession," Chandler said, "without apparently offering inducements of any kind."

Go deeper: Axios' Bill Bishop says a Trump-Xi meeting is exactly what the Chinese want

Dion Rabouin

History: Ngozi Okonjo-Iweala is an economist and international development expert who served for 25 years on the World Bank and rose to become the organization's managing director of operations, the global bank's No. 2 overall position.

She sits on the boards of Standard Chartered Bank, Twitter, Global Alliance for Vaccines and Immunization and the African Risk Capacity. She has sat on the board of the Rockefeller Foundation.

She was listed as the most powerful woman in Africa by Forbes and joined Nigerian billionaire businesswoman Folorunsho Alakija, for a time the richest black woman on Earth, on Forbes' list of most powerful people in the world.

Okonjo-Iweala has been one of the most honored leaders in the world, having been named:

  • One of the 50 Greatest World Leaders (Fortune, 2015)
  • One of the Top 100 Most Influential People in the World (TIME, 2014)
  • A Top 100 Global Thinkers (Foreign Policy, 2011 and 2012)
  • One of the Top 100 Most Powerful Women in the World (Forbes, 2011, 2012, 2013 and 2014),
  • One of the Top 100 Women in the World (The Guardian, 2011)
  • One of the Top 150 Women in the World (Newsweek, 2011)
  • One of the Top 100 most inspiring people in the World Delivering for Girls and Women (Women Deliver, 2011)

Okonjo-Iweala also was listed among 73 "brilliant" business influencers in the world by Condé Nast International.