Aug 28, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness:

  • The pound fell by more than 1% after Prime Minister Boris Johnson asked Queen Elizabeth to suspend parliament for a month. (Bloomberg)
  • Purdue Pharma and its owners, the Sackler family, have proposed a settlement in the nationwide opioids lawsuit that would be worth $10 billion–$12 billion. (NBC News)
  • Philip Morris International and Altria are in talks for an all-stock merger that would reunite the broken-up tobacco giant. Shares of both companies sank on the news, with Philip Morris down nearly 8%. (Axios)
  • Exercise bike company Peloton announced its plans to file an IPO while disclosing recent losses of $195 million. (Axios)
1 big thing: The entire yield curve is inverted
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Data: Federal Reserve Bank of St. Louis; Chart: Chris Canipe/Axios

There had been debate among economists and fund managers about the importance of previous yield curve inversions, but Tuesday’s market action provided an unambiguous signal that investors are expecting a recession.

Driving the news: The U.S. Treasury yield curve completely inverted Tuesday, with 1-, 2- and 3-month Treasury bills all paying higher interest rates than 30-year Treasury bonds.

  • The yield on the 3-month bill moved as much as 52 basis points above the 10-year note (the highest since 2007) with the 10-year yield ending the trading day well below the 2-year — fully inverting another closely watched yield curve.

Why it matters: The 3-month/10-year and 2-year/10-year yield curve inversions are closely watched precedents of recession. Economists at the Federal Reserve recently called the 3-month/10-year inversion "the best summary measure" for an economic downturn.

The big picture: Despite President Trump's rosy assessment of the U.S.-China trade war, investors are growing more concerned that there is no end in sight and are buying up safe-haven U.S. government debt to take cover.

  • "Those looking for a recession in the next 12 months are nervous that any downturn in business optimism associated with the trade war will eventually trickle down to hiring and undermine consumer confidence," Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, wrote in a note to clients.

What's happening: Investors continue packing into the long end of the yield curve, bidding up prices and pushing down yields.

  • “As the curve inverts further, it has inspired more long-end buying,” Mike Lorizio, head of Treasuries trading at Manulife Asset Management, told Reuters.
  • Yields on the benchmark 10-year note fell to the lowest since 2016 and are now less than 20 basis points away from their lowest level in history, while the 30-year bond fell below 2%.

It was also the first time since 2009 that the S&P 500′s dividend offered a higher yield than 30-year Treasury bonds.

  • The only other time stock dividends on the U.S. benchmark index paid more than a 30-year government bond in the last 40 years was in March 2009, according to data from Bespoke Investment Group, CNBC reported.
2. Trump losing trade war credibility with everyone
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Data: S&P Global; Chart: Axios Visuals

President Trump's credibility on the progress of trade negotiations is eroding among investors, economists, and, perhaps most distressingly, the Chinese.

Few negotiators in Beijing see a deal as possible ahead of the 2020 U.S. election, in part because it’s dangerous for any official to advise President Xi Jinping to trust Trump will abide by terms of a deal, Bloomberg reported Tuesday, citing unnamed Chinese officials.

  • Trump claimed on Monday that Chinese officials had been in contact with “our top trade people” and said “let’s get back to the table.”
  • This was refuted quickly by Hu Xijin, editor-in-chief of China's state-sponsored Global Times newspaper. Hu has quickly become a mouthpiece of sorts for China's top officials.

Ratings agency S&P Global also expressed doubt about a trade war solution, joining other organizations with similar sentiments this week.

  • "The latest retaliations in the U.S.-China trade dispute seem to dash any chance of a near-term resolution," S&P ratings analysts said, highlighting fresh tariffs announced by the Office of the U.S. Trade Representative last week that would add an additional 5% tariff on the approximately $550 billion worth of goods the U.S. imports from China.
  • "[T]hese recent events have shaken investor confidence further, and incrementally worsened the global business and economic outlook."

Investor worry is growing about the president's ability to broker a near-term deal.

  • “From Friday to now has been just head-spinning on the trade issue,” David Donabedian, chief investment officer of CIBC Private Wealth Management, told Bloomberg. “I don’t think the president’s recent comments marked the beginning of a solid or consistent trajectory to a resolution here.”
3. U.S. consumers remain historically confident
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Data: The Conference Board and University of Michigan; Chart: Axios Visuals

The continued bright spot in global economic data has been the solid state of U.S. consumers. Unemployment is low, and consumers are confident and continue to spend freely, providing a major buoy for the rest of the economy.

What they're saying: “It’s good to remind one’s self about what the fundamental, underlying drivers of the economy are," Scott Clemons, chief investment strategist at Brown Brothers Harriman, says in an email.

  • "Trade, as important as it is, and as many headlines as it engenders, is 3-4% of GDP. Personal consumption is closer to 70% of GDP. And as long as the labor market is strong, wages are OK, and we’re in a non-inflationary environment, the consumer keeps spending.“

Of note: Both major readings of U.S. consumer confidence remain at elevated levels.

  • However, the University of Michigan survey has been trending lower since May when the U.S.-China trade war began to escalate.
  • The Conference Board's survey has remained near historic highs, with a measure of how consumers view their present situation at the highest since just before the 2000 dot-com bubble crash.

The bottom line: “The trade disputes are like waves crashing on the shore. The economic tide, driven by personal consumption, is still coming in," Clemons adds. "The risks of recession are way overstated, given the strength of the consumer."

4. Millennials aren't ready for recession

The American dream is on hold, Axios' Justin Green writes.

By the numbers: Some indicators of what's happening...

  • Millennial homeownership is 8 percentage points lower than previous generations at this age.
  • Student debt is at $1.5 trillion, with defaults rising.
  • Just 37% of Americans under 35 owned stocks last year, vs. 55% in 2001.

The big picture: "The net worth of your average Millennial household is 40 percent lower than for Gen X households in 2001 and 20 percent lower than for Baby Boomers’ households at the end of the 1980s," notes Annie Lowrey in The Atlantic.

Between the lines: "The generation unlucky enough to enter the labor market in a recession suffers 'significant' earnings losses that take years and years to rebound," Lowrey reports.

  • "As of 2014, Millennial men were earning no more than Gen X men were when they were the same age, and 10 percent less than Baby Boomers."
  • "Millennial women were earning less than Gen X women."

Why it matters: The human costs are huge, leading to delayed family formation and more people living a paycheck away from disaster.

  • The parents of millennials — the boomers — are hurtling into retirement with children who may be less financially able to help.
  • The children of millennials — Generation Alpha — will almost certainly face the prospect of taking on even more student debt, with parents less able to help, absent a major public policy shift.
  • And millennials themselves are often stuck living in high-cost cities in order to get jobs that pay enough to tackle their loans.

Of note: All this is during a booming economy!

Go deeper: The global fear of too few young people

Dion Rabouin