Sep 4, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness:

  • Hong Kong stocks jumped more than 5%, after embattled leader Carrie Lam told officials a controversial extradition bill will be withdrawn after weeks of protests. (Bloomberg)
  • Fears of a German recession are rising and a downturn in Europe’s largest economy could spread across the region. (The Economist)
  • Prime Minister Boris Johnson will call for new elections after a major defeat in Parliament on Tuesday night as lawmakers voted to seize control of the Brexit agenda. (AP)
  • OxyContin maker Purdue Pharma is preparing to file for bankruptcy protection before the end of the month if it does not reach a settlement with a group of state attorneys general over widespread opioid litigation. (Reuters)
1 big thing: The case for being bullish

Illustration: Aïda Amer/Axios

There is doom and gloom abound in the market thanks to deteriorating economic data and growing global uncertainty, but many top fund managers and analysts remain bullish — and it's not just a case of rose-colored glasses.

The big picture: All the talk about recession related to market indicators like the inverted yield curve is becoming a "hysteria," says Sonal Desai, Franklin Templeton's CIO of fixed income.

  • That hysteria is causing investors to ignore clear signs of strength for the U.S. economy, such as the continued robust pace of jobs growth even with unemployment at a 50-year low, she argues.
  • Plus, there's the fact that wages and salaries grew 5.1% in the first half of the year with the household savings rate at a healthy 8.1% as of June, she adds.
  • Furthermore, the Fed also has ignored the data and started easing monetary policy, which is bolstering bond prices (and pushing down yields) while also cushioning the economy.

"Certainly, ongoing trade tensions are weighing on the parts of the manufacturing sector exposed to international trade and have contributed to market volatility," Desai tells Axios. "However, I do not see consumers panicking when we have record [high] levels of employment despite market volatility."

What's happening: Jim Paulsen, chief investment strategist of the Leuthold Group, agrees. He recently argued on CNBC that the market is caught in a "fear bubble" pushing investors into bonds with historically low yields instead of stocks that are near record highs.

  • "If we are headed for an imminent recession, it will likely be the most widely anticipated and best predicted recession ever," Paulsen tells Axios in an email.

He points to the substantial amount of government spending buffeting the economy — "one of the largest non-recessionary fiscal accommodations in the post-war era" — and the accelerating annual growth of real U.S. money supply as factors that should give the stock market a boost for at least the rest of the year.

Watch this space: Investor fear has tipped Bank of America Merrill Lynch's flagship positioning model to a contrarian "buy signal" for risk assets for the first time since Jan. 3, analysts said in a recent note to clients.

  • This implies the S&P 500 and MSCI's All-Country World Index are set to again push toward their all-time highs and drive Treasury yields and commodity prices higher.

Yes, but: Weak manufacturing data Tuesday (see below) capped a spate of declining economic indicators over the past several weeks, including falling U.S. consumer sentiment and imploding manufacturing surveys around the globe.

  • “The deterioration referred to has largely been in sentiment and survey-based indicators," Desai says. "I would need to see some more softening in hard data to start worrying about an imminent recession."
2. U.S. manufacturing data rolls over
Expand chart
Reproduced from a chart by Ian Lyngen at Bank of Montreal; Chart: Axios Visuals

Axios Markets readers have been highly attuned to the deteriorating state of U.S. and global manufacturing for months now, but on Tuesday Wall Street took its first real interest in the data.

By the numbers: The ISM's manufacturing survey came in at 49.1 in August, well below consensus and signaling the entire sector is contracting for the first time since 2016.

  • The new orders component of the survey fell to just 47.2, well below forecasts and tied with 2012 as the lowest since early-2009.
  • Worse, notes Ian Lyngen, head U.S. rates strategist at BMO Capital Markets, the all-important new orders vs. inventories spread dropped to -2.7 points, which is the weakest since 2012.

What they're saying: "If there was any question whether or not the trade war was hurting manufacturing sentiment, today's release cleared that up with the insightful observation that '[c]omments from the panel reflect a notable decrease in business confidence,'" Lyngen writes in a Tuesday note to clients, quoting directly from the ISM release.

Between the lines: The spread between ISM's new orders reading minus its inventories offers context for the recent trend, Lyngen adds.

  • "While not definitive, there is a clear correlation between a negative spread and an economic recession. The logic holds that if inventories are building faster than new orders are coming in, there is a problem on the horizon."
  • It's "rare to see this negative outside of a recession."
3. A $15 billion lifeline for Iran nuclear deal

Seeking to uphold the 2015 Iran nuclear deal and maintain some semblance of peace in the Gulf, France has proposed offering Iran about $15 billion in credit lines if Tehran comes back into compliance with the agreement, Reuters reports.

The catch: The prospective deal hinges on the Trump administration not blocking it.

  • "French Foreign Minister Jean-Yves le Drian said talks on the credit arrangement, which would be guaranteed by Iranian oil revenues, were continuing, but U.S. approval would be crucial," per Reuters.
  • The agreement would provide “a credit line guaranteed by oil in return for, one, a return to the JCPOA (Iran nuclear deal) ... and two, security in the Gulf and the opening of negotiations on regional security and a post-2025 (nuclear program),” Le Drian told reporters. “All this (pre)supposes that President Trump issues waivers.”

Why it matters: Iran is a key player in the oil market and its declining economy is a key risk for the Middle East and Europe.

  • A destabilization could trigger another serious refugee crisis in addition to the danger of its potential nuclear capabilities.
  • European leaders have scrambled to find a solution for Iran's faltering economy since Trump pulled out of the deal last year.
4. Fed discord could mean future headaches for Powell

The fight over the future of monetary policy at the Fed sharpened publicly on Tuesday ahead of the upcoming meeting this month.

What's new: Boston Fed president Eric Rosengren made the case against another cut to U.S. interest rates while St. Louis Fed president James Bullard said he would be in favor of a 50 basis point cut.

  • Rosengren and Bullard, both voters on the Fed's rate-setting committee this year, have been vocal about holding opposite positions on the rate-cut debate since July.
  • But yesterday's comments showed the two are moving further apart on their respective stances rather than coming together.

Why it matters: The Fed delivered the first non-unanimous rate decision of Chair Jerome Powell's tenure in June and in July it saw 2 dissenting votes.

  • The increasing polarity of opinions on the Fed does not bode well for a central bank facing an unprecedented era in monetary policy and worsening U.S. and global economic data.

The intrigue: Bank of America Merrill Lynch research analysts said in June they were anticipating as many as 3 dissenting votes at that month's meeting. There was only 1, but more could very well be coming.

  • With unemployment and retail sales data holding strong, but manufacturing and business sentiment data weakening, Powell could face increasing scrutiny from members of the Fed no matter which direction he looks to take with policy.
Dion Rabouin