HIGHLIGHTS

• Stocks fall slightly, by 0.23% in the US and 0.52% x-US.
• Reports earlier today that China will increase penalties on IP theft.
• The increase in the Fed balance sheet since September has coincided with the recent market rally.
• Strong reports on residential real estate.
• Higher threat of leveraged loan defaults.

MARKET RECAP

The market rally went on hold this week as US stocks declined by 0.23% and international equities fell by 0.52%. Bonds rallied as the longer end of the curve saw interest rates fall. The spread between the 2 and 10-year treasuries declined by 7 basis points. Progress on the trade dispute between the US and China also seemed to stall, but it was reported just a couple of hours ago (Sunday – 11/24/2019) that China has agreed to increase penalties on the theft of intellectual property, a major sticking point in the trade talks.

FED BALANCE SHEET

The Fed has increased the size of its balance sheet from about $3.76 trillion in early September to about $4.03 trillion currently. That is an increase of $270 billion in just 2-1/2 months. The purpose of the increase was to stabilize the repo market, and the Fed has claimed that this is not quantitative easing, but the effect is the same. More assets in the system provide more fuel to push equity prices higher. Not coincidentally, the market has been moving higher since the change in policy.

HOME SALES / BUILDING PERMITS

Good news on the residential front, existing-home sales increased 4.6% year over year. That was the fourth consecutive month of higher sales which followed a 16 consecutive month decrease. Building permits for privately-owned housing units were up 5% in October from September and 14.1% year over year.

LEVERAGED LOAN DEFAULTS

Analytics firm Credit Benchmark says that a recent survey of data collected from banks, insurers, and asset managers has raised the average probability of defaults on leveraged loans to about 6% in September versus 5.4% one year prior. Leveraged loans are often used by private equity for financing the buyouts of companies. Given the recent run of low-interest rates over the last decade, many companies are now loaded up on such loans. Almost 60% of companies purchased in leveraged buyouts carry debt of more than 6x earnings before interest, taxes, depreciation, and amortization (ebitda). A turn in the economy could lead to trouble for these companies quicker than normal.

SCOREBOARD

HIGHLIGHTS

• US stocks are up by 0.86% as the indexes hit a new record.
• The Dow breaks 28,000.
• Kudlow says progress on trade talks.
• Fed says rates to remain steady.
• Retail sales up 0.3%.
• Q4 growth is barely above breakeven according to two Fed bank models.

MARKET RECAP

US stocks managed another advance, +0.86%, but international stocks were unable to follow, declining by 0.07%. Bonds advanced by 0.54% as interest rates fell slightly. The Dow Jones Industrial Average closed above 28,000 on Friday for its eleventh record high of the year. There continues to progress in the US/China trade talks according to White House economic adviser Lawrence Kudlow and the Fed said rates would remain steady for now. US retail sales were up by 0.3% in October, showing that the US consumer is still going strong.

Outside of the markets, the impeachment investigation of President Trump went public this week, with hearings in the House. Bolivian President, and socialist Evo Morales resigned and fled the country.

GDP FORECASTS

Stocks have been going up, but GDP forecasts have been headed in the other direction, down. The Q4 forecast for GDP growth comes in at 0.30% for the Atlanta Fed’s GDPNow model, and the NY Fed’s Nowcast registers a gain of 0.39%, both barely above zero.

FED

Federal Reserve Chairman Jerome Powell does not see the need for further rate cuts, in testimony to lawmakers this week. “We see the current stance of monetary policy as likely to remain appropriate as long as incoming information about the economy remains broadly consistent with our outlook of moderate economic growth.” Powell went on to state that the Fed, at this time, does not have the ammunition it did in the past to fight a future recession given that interest rates are so low.

SCOREBOARD

HIGHLIGHTS

• US stocks up by 2.42% and international +1.84%.
• Optimism on US-China trade talks.
• Stocks appear to be in good technical shape.
• Bonds fall by 0.72% as interest rates are going up on the longer end of the curve.
• Negative yielding sovereign debt is down to $11.9 trillion from $17 trillion over the summer.
• Imports fell, job openings have declined (but still exceed the number of unemployed), and productivity turned negative.

MARKET RECAP

Equities had a big week around the world as “risk-on” appears to be back in mode, the US advanced by 2.42% and stocks x-US were up 1.84%. There is growing optimism that the US will avoid a recession, helped by supposed progress on a US-China partial trade deal, that will result in a rollback on some tariffs.

We showed a chart similar to the one below at the October webinar and described a “wedge” pattern, and the market has clearly broken out to the upside since then. Time will tell if the market can hold these gains and advance further, but stocks appear to be strong from a technical standpoint.

Bonds fell by 0.72% as interest rates further out on the curve increased. The yield on the 2-year Treasury was up by 12 basis points while the 10-year yield increased by 21 basis points. Interest rates have also been increasing worldwide. There is now an estimated $11.9 trillion in negative-yielding sovereign debt, down from $17 trillion over the summer. The 20-year US treasury has lost about 8% since mid-August.

While optimism is winning the day in the equity markets, the economic statistics are still mixed at best, as shown by some recent reports below.

IMPORTS FALL

Imports for September fell by 1.7% from August according to the Commerce Department. Consumer goods declined by 4.4%, a sharp drop that might indicate that the US consumer is slowing down on spending and/or that tariffs are beginning to impact sales.

JOB OPENINGS DECLINE

There are still plenty of jobs around and the labor market appears strong, but the number of unfilled jobs was a seasonally adjusted 7.02 million at the end of September, according to the Labor Department. That is is the lowest number in 18 months. However, the number of openings still exceeds the number of unemployed by 1.26 million.

PRODUCTIVITY

US worker productivity declined in the third quarter, it was the first quarterly decrease since 2015. However,  year over year, productivity was still up by 1.4%. That is in line with the 1.3% average from 2007 to 2018, but lower than the 2.1% annual average since the end of WWII. Economic output is a function of changes in productivity and population growth. With population growth stalling, productivity has to improve for the economy to accelerate its rate of growth.

SCOREBOARD

MARKET RECAP

Stocks moved into record territory as the US up by 1.55% and international stocks advanced by 1.30%. As anticipated, the Fed cut rates by 1/4% and a strong jobs report indicated that a recession does not appear in the cards for at least the very near term. On the other hand, the Chicago PMI came in at a dismal 43.2, the lowest level since December of 2015, but that number might have been impacted by the GM strike. Q3 GDP growth came in at 1.9%, it was the third straight drop in growth, 10 basis points off the Q2 number. The early GDPNow estimate for Q4 is 1.1%.

FED

The Fed cut interest rates for the third time in 2019 by 1/4 point. The move was widely anticipated by the markets. The Fed indicated that there would need to be a deterioration in the economy for another rate cut.

JOBS

The US jobs machine put in another strong month, lodging an increase of 128,000 in nonfarm payrolls, and that was after a decline of 41,600 due to the GM strike and 20,000 temporary census workers leaving their jobs. The two prior months were revised up by 95,000. The unemployment rate increased to 3.6% as more Americans entered the workforce. Average hourly earnings were up by 3% year over year.

EARNINGS

Through Wednesday, about 75% of S&P 500 companies have reported earnings and 75% have beaten expectations. However, overall profits are forecast to fall by 3.2% from last year. That would make it three quarters in a row of declining earnings. Analysts are expecting positive earnings growth in 2020 and 2021 of about 6 and 7%, respectively, although those estimates will probably come down.

BUDGET DEFICIT

Last week the Treasury Department reported that the budget deficit for the year ended 9/30/2019 was $984 billion, up 26% from the prior year. Tax receipts were up by 4%, while outlays were up by 8.2%. This is now the fourth consecutive year of an increasing deficit and the current shortfall was 4.6% of GDP, which is the largest amount excluding a war or a recession. The worst part is no one in Washington seems to care, under the guise that deficits don’t matter. The risk is that at some future point they will matter, and by then it will be very difficult to deal with.

SCOREBOARD

Leon Cooperman’s common sense letter to Senator Warren, click to read.

No update this week but below is the scoreboard. Contact us with any questions.

MARKET RECAP

Stocks advanced by 0.63% in the US and by 0.92% overseas. International stocks have been outperforming since mid-August. The graph below charts the ratio of US stocks (VTI) to stocks outside the US (VXUS) and the declining black line shows the outperformance of the international stocks.

The market is expecting another Fed Rate cut at the end of the month, and that is providing support to equities. The Fed also has started to increase the size of its balance sheet, buying $60 billion a month of treasury bills, although they are not calling it quantitative easing. The Fed is buying the bonds to ensure that there is enough money around so that the gears of the banking system can move in sync without crashing, as came close to happening last month in the repo market.

SCOREBOARD

MARKET RECAP

US stocks were up this week by 0.60% and international stocks had a big week, +1.96%. Stocks managed the advance on optimism of a breakthrough on the trade front with China. On Friday, it was announced that China would buy more US farm products and the US would hold off on further tariffs. The agreement was characterized as “phase one.” There was even a hint of some progress with Brexit. US stocks are now only 2% off the all-time high. Bonds dropped by 1% on higher interest rates and the 3-month/10-year curve went back to normal status (not inverted).

FEWER JOB OPENINGS

Job openings were 4% lower than one year ago, the third straight monthly decline. That hasn’t happened since 2009. However, August’s job postings overall still were greater than the number of unemployed by about 1 million.

GLOBAL GROWTH

Two top World Bank officials warned that “the global economy is now in a synchronized slowdown,” those were the words of Kristalina Georgieva of Bulgaria, the no. 2 official at the World Bank. David Malpass, who is the World Bank’s President, referring to their June forecast of 2.6% global growth in 2019, said: “We now expect growth to be even weaker than that, hurt by Brexit, Europe’s recession and trade uncertainty.” International Monetary Fund research shows that the cumulative economic loss from the trade war could amount to $700 billion by 2020. That would represent about 0.8% of global gross domestic product.

SCOREBOARD

MARKET RECAP

Stocks fell early in the week as disappointing PMI reports raised recession fears but rallied on Thursday and Friday on decent jobs numbers. Investors are expecting another Fed rate cut later in the month. Interest rates dropped sharply on the greater likelihood of a recession.

For the week, US stocks dropped by 0.38% and international markets were down by 0.66%. Bonds had a big rally due to the lower interest rates, up by 0.80%.

PMI

The Institute for Supply Management Purchasing Managers Index for manufacturing came in at a bleak level of 47.8 for September, down from 49.1 in August. It was the lowest level since June of 2009.  The trade war has been a drag on the PMI. “Global trade remains the most significant issue, as demonstrated by the contraction in new export orders that began in July 2019,” said Timothy Fiore, chair of the Institute for Supply Management.

A reading of less than 50 is considered contractionary. For the most part, past recessions have been preceded by a falling PMI that is less than 50, but there have also been false signals, including December of 2015 when the PMI hit 48 and August of 2016 when it hit 49.4.

Manufacturing only represents 8.5% of total employment and 11% of GDP. But a slow-down in the manufacturing sector can find a way to seep into the overall US economy. There was a sign that is happening as the non-manufacturing PMI fell sharply to 52.6 from 56.1.

JOBS

The decent jobs report shows that the economy is still hanging in there. The unemployment level fell to 3.5%, the lowest since December of 1969. Nonfarm payrolls increased by 135,000. That was less than the consensus estimate of 150,000, but the previous two months were revised up by 45,000. Wage growth month over month was flat, below expectations, year over years wages are up by 2.9%.

IMPEACHMENT

The impeachment process rolled on as the embarrassing political situation remains a complete mess and the chances, while still very early, seem to be increasing that the winner in 2020 will represent the extremes of their respective parties (Trump or Warren). Neither choice is encouraging.

SCOREBOARD

MARKET RECAP

US stocks dropped by 1.14% and international stocks were down by 1.23%. An impeachment inquiry began on Trump, the repo market needed more help, and Germany seems close to a recession, add on to that a word that the US might delist Chinese companies from US markets, and it was enough to push stocks lower for the week.

TRUMP

House Speaker Nancy Pelosi began an impeachment inquiry of Trump after a whistle-blower complaint that the President withheld military aid to Ukraine in order to pressure them to investigate Joe Biden and his son.

REPO MARKET

The Repo market was in need of continued help this week. The Fed injected $50 billion on Monday and then doubled that by midweek. The problems most likely stem from the draining of reserves from the system.

GERMANY

The German IHSMarkit composite output index entered contractionary territory for the first time since April of 2013. The rate of decline was the steepest in seven years. Growth in the service sector slowed sharply. For the manufacturing index, it was the eighth straight decline in output.

Phil Smith, Principal Economist at IHS Markit said: “Another month, another set of gloomy PMI figures for Germany, this time showing the headline Composite Output Index at its lowest since October 2012 and firmly in contraction territory. “The economy is limping towards the final quarter of the year and, on its current trajectory, might not see any growth before the end of 2019. “The manufacturing numbers are simply awful. All the uncertainty around trade wars, the outlook for the car industry and Brexit are paralyzing order books, with September seeing the worst performance from the sector since the depths of the financial crisis in 2009. With job creation across Germany stalling, the domestic-oriented service sector has lost one of its main pillars of growth. A first fall in services new business for over four-and-a-half years provides evidence that demand across Germany is already starting to deteriorate.”

WE WORK / PELOTON

We Work pulled its IPO last week after it was apparent that the public markets would not value the Company at any level close to its recent private valuations. Adam Neumann, We’s dynamic founder, subsequently stepped down after pressure from its lead investors.

Peloton didn’t have to pull back its IPO, but its offering did not go as expected, dropping 10% on its first day. Further evidence that the public markets are taking a more rational approach to valuation, and that artificially low-interest rates and easy money have given many start-ups and their private investors a sense that positive cash flow simply doesn’t matter, but ultimately, it does, at least recently.

SCOREBOARD