Aug 27, 2019

Axios Markets

Dion Rabouin

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Situational awareness:

  • The German economy contracted in the second quarter, largely due to the significant slowdown in manufacturing. Economists expect it will contract again in Q3. (Reuters)
  • The Chinese yuan's offshore level fell to its weakest ever against the dollar Monday, and the dollar hit its weakest level in 2.5 years against the Japanese yen. (CNBC)
  • Struggling pizza company Papa John’s is poised to name Arby’s president Rob Lynch as its new CEO, replacing Steve Ritchie. (Bloomberg)
  • Costco had to shut down its first warehouse club in China just a few hours after opening because of overcrowding, with cars backed up 3 hours waiting for parking spots. (Quartz)
1 big thing: The stock market is running out of reasons to go higher

Photo: Eduardo Munoz Alvarez/Getty Images

Stocks jumped on Monday as investors bought optimism that a U.S.-China trade deal could be salvaged, despite a lack of tangible evidence that progress is being made.

  • The market will need the animal spirits of trade-war hope, because many of the fundamental catalysts that have buoyed stock prices in years past are starting to unravel.

By the numbers: S&P 500 companies are headed for an "earnings recession" to start the year, with earnings down 1.4% and 1.3% year-over-year in the first and second quarters of 2019, respectively, data from Morgan Stanley shows.

  • Profits, even at small and private companies, are turning negative, according to data from the Commerce Department's national income and product accounts.
  • Total U.S. corporate profits have fallen by close to 10% since the third quarter of 2018.

Why it matters: "Every time these profits have contracted in the past, the next 12 months’ job growth has been negative," Lisa Shalett, CIO of Morgan Stanley Wealth Management, said in a note to clients Monday. She is expecting the S&P 500 to drop to around 2700, thanks to the continued erosion of earnings and profit.

  • "As was the case in 1999, when S&P 500 profits diverged from the broader profit measure, the outlook for stocks is not positive."

Investors are undervaluing the negative impact of the earnings recession, Morgan Stanley's chief U.S. equity strategist Mike Wilson warns.

  • Stocks were able to power through the last earnings recession in 2016, but there isn’t enough economic growth to get out the hole this time, he says, noting declining jobs growth and the ongoing U.S. transportation recession.

But wait, there's more. Companies are slowing the pace of stock buybacks this year, withdrawing a major buyer from the equity market as both institutional and retail investors have been net sellers of equities all year.

  • The stock market also will have to make up for the muted performance of the FAANG stocks, as shares of Facebook, Amazon, Apple, Netflix and Google parent Alphabet have provided limited upside over the past year, WSJ notes.
  • "All the stocks, with the exception of Alphabet, peaked last year and remain well below their records after a brutal selloff last fall wiped out billions of dollars in market value. The stocks have shed nearly $415 billion since August 2018 when their combined market value swelled to $3.7 trillion," writes WSJ's Michael Wursthorn.
  • FAANG stocks account for around 20% of the S&P 500's value.
2. Despite volatility, oil prices flat in August
Expand chart
Data:; Chart: Axios Visuals

Oil prices have been incredibly volatile so far this year, having fallen around 20% from their 2019 high reached in April. That gave back most of the gains from a 30% rise to start the year.

  • But ever since recovering from June's meltdown, the market has been unable to sustain momentum in any direction.
  • August has been perfectly emblematic of the sideways summer trading: WTI crude prices started the month at $53.95 per barrel after a nearly 8% selloff on Aug. 1, and closed on Monday at $53.98.
3. J&J stock soars after opioid ruling

Illustration: Sarah Grillo/Axios

Johnson & Johnson has officially been found liable in Oklahoma for deceptive and false marketing of opioids — the first major instance of legal accountability for the opioid epidemic, Axios' Bob Herman reports.

Why it matters: "This is the first time ... that a pharmaceutical company has been found responsible in the court of law for causing the opioid crisis," said Andrew Kolodny, a doctor and opioid researcher who was a key witness for Oklahoma in the case. "This is a landmark decision."

Yes, but: If Oklahoma's $572 million judgment is a sign of things to come, states may only be looking at short-term relief — and drug companies may only incur short-term annoyances, rather than crippling penalties.

  • The verdict sent shares of pharmaceutical companies skying. Johnson & Johnson stock jumped 5% in after-hours trading Monday, resulting in a $13.5 billion market cap gain.
  • Teva Pharmaceutical rose 5%, Endo International jumped 3% and Mallinckrodt gained as much as 7%.

Between the lines: $572 million is just the 1-year cost of abating Oklahoma's opioid crisis, the ruling says.

  • The state wanted $17 billion, but the judge said it didn't present enough evidence to validate a longer-term payout.
  • The judgment is less than 4% of J&J's net profit from 2018, and significantly less than the $2 billion some Wall Street analysts expected J&J to end up paying — and that's why shares of J&J and other related companies soared in after-hours trading.
  • If this case is used as a benchmark in the national lawsuit, J&J likely would pay billions — but again, not an insurmountable amount for a company that brings in more than $80 billion in sales annually.

What they're saying: J&J plans to appeal, saying in a statement the judge's decision was "flawed" and that it's ready to extend this fight.

4. Scammers target student loans as defaults surge

A growing crop of companies are targeting student debt borrowers by selling scams that promise to help reduce or forgive loans, often with upfront, illegal fees, WSJ reports.

Why it matters: A record $89.2 billion worth of student loans had been defaulted on at the end of June, while 11% of the $1.48 trillion in total outstanding loans was "at least 90 days behind on repayments," according to New York Federal Reserve data.

  • The companies identified by the WSJ — some of which are legally allowed to operate — have been flagged by regulators that warn the services they offer are usually free. Other companies are fraudulent, regulators say.
  • "Many of the [Federal Trade Commission] cases allege that the companies charged upfront fees for debt relief, which is illegal, or engaged in other prohibited practices such as masquerading as being government-approved, or faking information on applications for federal relief," WSJ's Jean Eaglesham, Michael Tobin and Coulter Jones write.

Reality check: Federal relief programs do exist and offer a reduction or forgiveness of debts for those who qualify, such as public service workers or people with low incomes.

  • Last week, President Trump signed an executive order that will cancel student loan debt for permanently disabled U.S. military veterans.
Dion Rabouin