Markets
(Beijing)
Happy new year—the Dow opened down 350 points this morning on fears over a Chinese slowdown. New data is out of the country which shows that Beijing’s manufacturing sector is contracting, a sign that tariffs may be flowing through to the economy. That makes markets hope more than ever for a trade agreement between the US and Beijing, which would likely alleviate the economic strain. The S&P 500 has fallen 20.2% on an intraday basis, an official bear market.
FINSUM: The implications of a big Chinese slowdown are serious. Firstly, how does the country react politically to what they likely view (or will project) as a US-imposed slowdown? Secondly, how much does the slowdown drag down the global economy?
(Washington)
If that headline sounds like relief to your ears, read further. While there are no clear signs out of the Fed yet (other than increasingly dovish talk), new data is showing that the Fed may cut rates in 2019. The forward spread shows that traders are anticipating a rate cut at the beginning of the year. Two-year Treasuries have seen their yields slip below one-years’. This is the first time this has happened since 2008. According to a market strategist at Pimco, “This is a crystal ball, it’s telling you about the future and what the market thinks of the Fed and what it will do with its policy rate”.
FINSUM: We don’t think the Fed will cut in the first quarter unless something more drastic happens, but we are quite sure they won’t hike.
(New York)
The market has been very worried about a potential bond market meltdown. Both investment grade and high yield debt have seen major losses lately as fears have mounted about high corporate debt heading into a possible recession and downturn in earnings. One of the big worries is that there will be a surge in BBB (the lowest rung of investment grade) debt that falls into junk status. However, Bank of America is more sanguine, arguing that growth is solid and companies have actually been issuing much less debt, and will continue to do so. Their view is that companies are in a much sounder financial position than before the last crisis.
FINSUM: The debt gorge that happened over the last several years is inevitably going to have consequences, and we think BAML is way too relaxed about the risks.
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(New York)
Where to put one’s money in 2019? That is the difficult question every investor must face at the moment. For a long time “TINA”, or “there is no alternative”, was the mantra which kept guiding capital into stocks alongside miniscule yields. Now with rates and yields rising and stocks having seen big losses, where should investors turn? The reality is that bonds seem likely to outperform stocks next year, at least according to JP Morgan. The bank thinks EM debt is likely to have a good year as once the Fed stops tightening the Dollar will likely weaken, giving a boost to EM assets.
FINSUM: In our view, a lot of damage has already been done to stocks and there are now some very interesting buys. Furthermore, short-term debt has seen yields rise high enough that you can get decent returns without a lot of interest rate risk.
(Washington)
For the last few weeks, the Fed looked like an out of touch ivory tower central bank committed to driving the US economy into a recession through relentless rate hikes (or at least that was the anxious view). However, the Fed has finally made an announcement which gave investors some calm. The head of the NY Fed commented that being “data dependent” meant listening to markets too, not just the economy. He also contextualized the language from the last Fed meeting, softening its impact. The market jumped immediately on the news.
FINSUM: Too bad it isn’t Jerome Powell making the comments. That said, the Fed must be starting to get nervous that we are close to a bear market.
(New York)
Small caps are in a major rut. The Russell 2000 peaked in August and is now on the verge of a bear market since then. Interestingly, small caps have fallen farther than their larger peers despite the fact that they are insulated from headwinds like the trade war. So how to pick them? The answer is to stay away from indexes and actually choose individual shares whose fundamental outlooks appear brighter than benchmarks. For instance, one fund manager says that investors should choose “quality value stocks” with “with high free-cash-flow yield, low net debt to earnings before interest, taxes, depreciation, and amortization, or Ebitda, and below-market volatility”.
FINSUM: Small caps are a hugely diverse sector and some shares will inevitably have bright outlooks no matter what else may be going on in the market. The issue, of course, is the time and selection necessary to find such shares. Perhaps actively managed small cap value funds are a good bet?