Volatility is Returning

The markets showed their weak hand this week as we saw stocks break down on Thursday and volatility spiked. Volatility has acted as a compressed spring all year so things may get interesting next week. If the selling continues Mon/Tue, then we may be in for that 5-10% correction I mentioned last week.

I still see earnings announcement met with generally lower stock prices so that is a yellow flag in my book. In an unusual move from the banks, I have read commentary from Citibank and Merrill Lynch that is warning clients on equity valuations and general investor complacency which is a first for the uber-bulls on Wall Street.

See below: Savita Subramanian, head of U.S equity and quantitative strategy at Merrill Lynch, projects that the annual growth rate for S&P 500 earnings will decline from 8% in 2017 to 5% in 2018. An additional matter of concern is that, while large numbers of S&P 500 companies are beating earnings expectations during the second quarter, that good news is not propelling shares upward, for the most part. “This could be a warning sign that equity market expectations and positioning more than reflect the good results,” the Merrill Lynch note observes that a similar scenario last appeared in the second quarter of the year 2000, while the dotcom bubble was bursting.

Best not to chase stocks here even if we recover to new highs next week. The bull market is long in the tooth and it may need a root canal.

New paradigm


Economic & Central Banking Snippets

  • Another disappointing CPI report (5 months in a row). Core CPI up 0.1% with weakness driven by a record drop in lodging of -4.2% and there is a drag in auto prices. There are a number of categories holding back core inflation which threaten to continue. The weakness in CPI follows a weak PPI report and continued soft wage measures.
  • U.S. consumer credit-card debt just passed an ominous milestone, beating a record set just before the global financial system almost collapsed in 2008.

Total revolving credit, owned, securitized and outstanding.


Politics! Politics! Politics!

  • Through July, new municipal deals to fund transportation, utilities and power projects totaled $50.7B, down 19.4% from the same period last year, according to Thomson Reuters data. One reason could be the future of infrastructure investment. President Trump has promised $1T over the next decade, but the administration has produced few details regarding funding.
  • Venezuela’s new constitutional assembly has assumed even more power by declaring itself as the superior body to all other governmental institutions. The unanimously approved decree prohibits lawmakers in the opposition-controlled congress from taking any action that would interfere with laws passed by the newly installed assembly.
  • Philadelphia’s tax on sugary drinks has made soda more expensive than beer in the city. A new study from the Tax Foundation found that the 1.5% per-ounce tax has fallen short of revenue projections and has forced some Philadelphians to drive outside the city to buy groceries. It’s also hit the corporate level: PepsiCo is laying off up to 100 workers because of the tax.
  • The Fiscal Times rates over 100 municipalities based on their fiscal strength. Chicago is dead last. The city has little in reserve to cover unexpected expenses or a drop in revenue. Its general fund balance covers only 6.27% of annual expenditures. Meanwhile, Chicago carries a lot of debt. Its longterm obligations are almost 300% of revenue. The city spends one-fifth of its budget covering required pension contributions, but it’s still not enough. As of 2015, one of the city’s larger pensions held just 33% of what it needs to meet its obligations. The Municipal Employee’s Annuity and Benefit Fund had $4.7 billion in assets and owed $14.7 billion in benefits.


Not-So Fun-Fact Of the Week

  • Drug-related deaths. There seems to be no end in sight for this epidemic. (WSJ)

Drug overdose deaths involving various opioids.

Chart Time!

S&P 500 (SPY)
S&P 500 (SPY)


Russell 2000 - Small Caps (IWM ETF)
Russell 2000 – Small Caps (IWM ETF)




Market Snippets

  • The retail sector credit situation continues to deteriorate. The retail sector has always acted as the canary in the coal mine in my experience (see chart).

Distressed retail and apparel issuers

  • Financial institutions have paid more than $150B in fines in the US relating to the credit crisis, passing a significant milestone a decade after it became clear American subprime woes had become a global problem.
  • Apple is planning to release a version of its smartwatch later this year that can connect directly to cellular networks, a move designed to reduce its reliance on the iPhone, Bloomberg reports.
  • Tesla announced a $1.5B bond sale to boost its Model 3 production, marking the first time it has turned to the markets for an issue of straight debt. Tesla is trying to stave off the liquidity pressures caused by its headlong rush to become a mass-market car producer. According to Bloomberg, Tesla could wind up paying no more than 5% on the junk-rated bonds. (FT)
  • The price of aluminum, which is used in everything from drinks cans to cars to girders for construction, has traded above $2,000 a tonne for the first time in almost three years as China continues to crackdown on pollution and reform its bloated industrial base. Since the financial crisis, a supply glut has cast a shadow over the market for the lightweight metal. But this year the gloom has started to lift as China, which produces around half of the world’s aluminum, has moved to cut capacity.
  • Disney will end its distribution agreement with Netflix for subscription streaming of new releases starting in 2019. Some of the first releases for Disney’s proposed service will include “Toy Story 4,” the “Frozen” sequel and “The Lion King.” The company will also “make a significant investment in an annual slate of original movies, TV shows, short-form content and other Disney-branded exclusives for the service.”
  • Amid constant headlines about huge increases in the values of cryptocurrencies such as Bitcoin and Ethereum, the dental profession recently launched its own cryptocurrency, Dentacoin. Seriously.


International Snippets

  • It now takes 19,000 bolivares to buy one dollar on the black market in Venezuela as the currency collapse accelerates. Some stores are using a scale to weigh the currency rather than count it.

19,000 bolivares

  • Europe’s top official in charge of winding down failed banks has urged the EU to tighten restrictions on when governments can pump money into stricken lenders. Elke König, the head of the eurozone’s Single Resolution Board was responding to recent cases in Italy where senior bondholders were spared losses.
  • Abu Dhabi has launched an informal boycott of western banks with significant Qatari shareholders, broadening the impact of the Arab
    quartet’s two-month embargo against the gas-rich state. Officials have told bankers that lenders such as Credit Suisse, Deutsche Bank and Barclays are unlikely to win significant mandates in the capital of the United Arab Emirates in the coming months because of large shareholdings held by Qatar’s sovereign wealth fund and members of the ruling family.

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.