Feb 14, 2020

Axios Markets

🚨🚨Long weekend alert! We're taking Monday off to celebrate Presidents Day. Send me some suggestions for activities this weekend in Phoenix. (I do not golf!) I'll be back in your inbox on Tuesday.

Was this email forwarded to you? Sign up here. (Today's Smart Brevity count: 1,150 words, 4.5 minutes.)

1 big thing: Mexico's "Bernie Sanders" has made investors a fortune

Illustration: Aïda Amer/Axios. Photo: Pedro Martin Gonzalez Castillo/Getty Contributor

Under radical left-wing socialist President Andrés Manuel López Obrador, referred to as the "Bernie Sanders" of Mexico during his campaign, the country's assets have been "a virtual cash register" for investors.

  • While many have been skittish about embracing the controversial and unorthodox new president, during his tenure AMLO has made it rain on financial markets, boosting bond prices and pumping the value of the Mexican peso.

The big picture: Mexico's economy has struggled under AMLO, posting negative GDP growth last year and leading to consensus expectations for just 1% growth in 2020 (which analysts like those at Bank of America Securities think is still 50% too high). But economic progress hasn't been what's driving the gains.

What we're hearing: With yields on government bonds at or near record low levels in the U.S., eurozone and much of the world, asset managers are in desperate need of high-yielding, stable investments, and Mexican assets have been all that and more.

  • "Everybody is talking about Mexico. Probably because of how resilient it is and how it’s a virtual cash register," Marc Chandler, managing director at Bannockburn Global Forex, tells Axios. "It’s more a financial arbitrage story than it is about Mexican growth opportunities."

What it means: Despite its weak growth, Mexican 10-year government bonds have seen yields decline by a whopping 193 basis points over the last 12 months. That has compressed the spread versus comparable U.S. Treasuries by 86 basis points.

  • And Mexico's bonds still hold some of the highest yields in the world, so investors are rewarded by bond prices rising (as yields fall) and coupons that are more than four times higher than comparable U.S. government debt.
  • The value of the peso also has increased by around 3.5% in the past 12 months against the dollar, giving investors a triple win.

Yes, but: There is worry about how long the good times can last, given the world-beating returns Mexican bonds have had already and a lack of foreign direct investment from incredulous money managers.

  • "AMLO’s policies and rhetoric has dampened appetite for investment in Mexico and has increased uncertainty," Jared Lou, portfolio manager at William Blair & Company, tells Axios.
  • But Lou admits the Mexican president's conservative fiscal policy "has provided an unexpected anchor for bondholders."

Of note: The trade has been especially rewarding for investors against the euro.

  • The value of the euro has fallen by nearly 8% against the peso over the last 12 months in addition to the 140 basis points of spread compression for Mexican vs. European benchmark bonds.
Bonus: All the elements
Expand chart
Data: FactSet; Chart: Axios Visuals

The market believes the Mexican market bonanza has further to go.

By the numbers: Speculators increased bets that the peso will rise in value to record levels in the week ending Feb. 2, data from the CFTC shows. Bullish net-long bets rose for a fourth straight week, and have increased in seven of the last eight weeks.

  • The Bank of Mexico lowered interest rates Thursday and is expected to cut 100 basis points further this year to help stimulate the economy, according to current market pricing.
  • Even if the Fed doesn't cut rates this year, China's recent wave of stimulus measures to combat the novel coronavirus outbreak are also likely to help buoy Mexico's bonds and currency, Emily Weis, macro strategist at State Street, tells Axios.

What's next: "Mexico seems to have all the elements keeping investors there, unlike some other emerging markets," she says.

2. Catch up quick

Huawei and two subsidiaries were charged with racketeering and conspiracy to steal trade secrets, in addition to charges the company already faces that were filed last year. (WSJ)

Senate Republicans expect President Trump to withdraw his nomination of Judy Shelton to the Fed Board after she faced significant opposition during her hearing yesterday. (The Hill)

Wayfair plans to lay off more than 500 employees, or 3% of its total workforce. (Business Insider)

A judge has granted Amazon's request for a temporary block on the JEDI cloud contract that was awarded to Microsoft last October. (CNBC)

3. What has happened to inflation
Expand chart
Data: Bureau of Labor Statistics, reproduced from Deutsche Bank; Chart: Axios Visuals

For the past 25 years, the U.S. has seen zero inflation in goods and 3% to 4% inflation in services.

What's happening: Deutsche Bank Securities chief economist Torsten Slok said in a recent note to clients...

"[There's] more openness to foreign trade holding down goods inflation, higher productivity growth in manufacturing than in services holding down inflation on goods, and higher growth in demand for services as per capita income rises and the population ages."
"Looking ahead, for higher inflation to become a problem, we either need to see goods inflation move higher, for example because of a significant dollar depreciation, or we need to see even higher inflation in the costs of housing, healthcare and education."

Details: Goods are things you buy in stores and services are housing, health care and education, Slok notes. The weight to goods in the CPI index is 1/3 and the weight to services is 2/3.

4. NY Fed: Boeing's production freeze will cut U.S. GDP growth by 20%

Analysts at the New York Fed expect the all-out production stoppage on Boeing's 737 MAX will have a sizeable negative impact on U.S. growth this year.

  • The decline will produce a 0.4 percentage point decline in GDP growth, the NY Fed's Julian di Giovanni finds.

Why it matters: "This is a significant fall given an average quarterly GDP growth of 2 percent," di Giovanni writes in a recent Fed blog.

Background: Prior to the slowdown in production that began in 2019 after nearly 350 people died in two plane crashes, Boeing was producing roughly 52 of those models on average per month. It's assumed this number will be zero for the first quarter of 2020.

  • Assuming workers' productive capacity, even if they are not laidlaid off, is zero, and suppliers are all domestic, di Giovanni applies Hulten’s theorem to the implied percentage change in sales from the 737 MAX production stoppage to calculate the total loss.

By the numbers: "Boeing averaged about $25 billion in quarterly revenue in 2018. Assuming that the average price of a Boeing 737 MAX is roughly $130 million, a pause in all production and sales implies lost revenue of $7 billion per month, or $21 billion for the first quarter of 2020."

  • "This then implies a sales loss of roughly 84 percentage points relative to an average quarter in 2018."
  • "Treating this sales loss as the firm shock, the lost GDP growth is then Boeing’s Domar weight times this loss (0.0047*–0.84 = –0.004), or a 0.4 percentage point decline in GDP growth."
5. Earnings on pace for a strong rebound
Expand chart
Data: FactSet; Chart: Axios Visuals

Thanks to a cadre of better-than-expected earnings results from the companies that have reported their fourth quarter earnings so far, the earnings growth rate for the S&P 500 has risen to 0.7%.

Why it matters: That is a far cry from the estimated earnings decline of -1.7% at the end of the quarter. If it holds, this would mark the first time the index has reported year-over-year growth in earnings since Q4 2018. 

What's happening: Positive earnings surprises have led to a net $8.5 billion increase in earnings for the index since Dec. 31, FactSet senior earnings analyst John Butters notes.

  • This has been driven largely by IT companies, which have accounted for $5.4 billion of the net $8.5 billion increase (or about 63%).
  • "The positive earnings surprises reported by Apple ($4.99 vs. $4.55), Microsoft ($1.53 vs. $1.32), and Intel ($1.52 vs. $1.25) were substantial contributors to the increase in earnings for the index during this time," Butters says.
6. JPMorgan handicaps the coronavirus outbreak
Expand chart
Reproduced from a JPMorgan report. Note: Forecast is before the
revision curve (i.e. excluding clinical diagnoses cases). Table: Axios Visuals

In case you were wondering...

Philip Emeagwali is a poor Nigerian who dropped out of school and lived for years as a refugee but went on to became one of the founding fathers of the internet.

  • Emeagwali developed the idea to get machines from all over the world to "talk to each other," by employing thousands of microprocessors to perform a series of computations, eventually creating a machine that was able to perform 3.1 billion calculations per second.
  • He was awarded the 1989 Institute of Electronics and Electrical Engineers' Gordon Bell Prize, considered the Nobel Prize of computing, and has since won more than 100 prizes for his work. Apple used his microprocessor technology in its Power Mac G4 model.

He was awarded the 1989 Institute of Electronics and Electrical Engineers' Gordon Bell Prize, considered the Nobel Prize of computing, and has since won more than 100 prizes for his work. Apple used his microprocessor technology in its PowerMac G4 model.

Editor's note: The headline in item number 4 was changed to clarify we were referring to GDP growth.