Signals

Stocks finished on a good note this week as a key technical level was recaptured in the S&P 500 (2,600). See below:

We are not out of the woods yet but the technicals over the last few weeks are undeniably favorable to calling the Christmas low a bottom. It may not feel like a bottom as much in the news cycle has been negative. No doubt, growth is slowing and we are probably seeing the early warning signs of a credit cycle brought on by a tightening policy by central banks. But there may be a window where some of the current concerns in the market are alleviated and the market pops to one more new high.

Is there precedent for this type of environment? Well, if you look at the years leading up to the 2008 financial crisis: real estate prices topped in 2005; sub-prime mortgages started defaulting in late 2006; the stock market topped in 2007 which eventually lead to a crash in 2008. Hard to say where we are in comparison but are getting closer to the end of this business cycle.

What might be the Positive Signals in the coming weeks:

1. China and the US agree to more definitive terms on a trade deal.
2. The next Fed meeting on January 30th sends a message that there will be little to no tightening for the next several months.
3. Italy’s weak economy causes the European Central Bank (ECB) to blink in tandem with the Fed and they continue to buy crappy corporate bonds providing stimulus to the Euro zone.
4. The government shutdown ends.
5. Earnings are disappointing but still pretty good.
6. High yield bond issuance picks up.

What are the Negative Signals:

1. Growth is decelerating across the globe.
2. Weak credits are continuing to default like Sears and PG&E along with many smaller retail companies.
3. Volatility is higher. I see this across the board now in commodities, currencies, stocks and now corporate credits.
4. Consumer, corporate and sovereign debt is reaching levels that are not sustainable at higher interest rates. The next credit cycle will take place on may levels and be protracted.
5. The U.S. banking system is on solid footing but I can’t say that for Europe, China and Japan. U.S. banks could be infected via the derivatives market through counterparty risk.

So, short-term we probably have a bottom in stocks which may mean a few good months to new all-time highs. Longer-term, we have some issues. In either case, we can use 2,600 in the chart above as a signal of direction for the stock market.

What to watch next week:

1. China’s Q4 gross domestic product.
2. Durable Goods Orders (Friday).
3. Earnings season will pick up so reactions to the news will be important.

Chart of the Week!

Economic & Central Banking Snippets 

• Germany’s economy slowed sharply last year, shaken by softening consumer spending at home and weakness in several key export markets. In 2018 as a whole, Germany’s gross domestic product increased 1.5% from a year earlier – the slowest since 2013 Germany’s slowdown is an ominous sign for the health of the world economy. (WSJ)

• Federal Reserve Governors continued to get the message out this week that they are dialing back their tightening policy. One of the more hawkish members, Esther George, gave a speech calling for a Fed time out. “It might be a good time to pause our interest rate normalization, study the incoming evidence and data, and verify our current location…It is possible that some additional rate increases will be appropriate. But making that judgment is not urgent…”. This is no doubt a response to the volatility that we saw in the stock market from the last few months.
• The Federal Reserve released its Beige Book report this week which is a roundup of data from all 12 Fed districts. This report showed that the economy continues to grow at a modest to moderate pace, however, many districts “had become less optimistic” on the US economy and firms are pulling back on planned investments and paring back 2019 forecasts. The districts heard concerns about rising short-term interest rates, political and trade uncertainty, and volatility in the financial markets, the central bank said. (MarketWatch)
• Industrial Production rose more than expected in December (up 0.3% vs 0.2% exp), albeit with a downward revision for November. This was driven by a 1.1% MoM surge in Manufacturing output, the most since Feb 2018 thanks to the motor-vehicle segment.
• The Bank of Italy said on Friday that the country’s economy may be in a recession and estimated sharply lower growth for 2019. The Italian economy contracted by 0.1% in the third quarter, meaning that if the Bank of Italy’s forecasts are correct then the economy will have shrunk for two consecutive quarters.
• There is a credit cycle brewing in China which will be a bigger deal a year from now. We haven’t seen China go through a credit cycle and this looks to be a biggie. No doubt you will see credit spreads continue to widen across the globe as interest rates go higher which makes it more difficult for companies to repay their debt.

Macro Snippets

• Citigroup’s revenue fell to a two-year low in the final quarter of last year, as a sharp drop in fixed-income sales and trading earnings took a heavy toll on one of America’s biggest banks. 
• PG&E says it is preparing to file for Chapter 11 bankruptcy to “support the orderly, fair and expeditious resolution of its potential liabilities resulting from the 2017 and 2018 Northern California wildfires.” Nearly all of PG&E’s bonds traded lower this week after the company failed to make a $21.6M interest payment on its 2040 senior notes.(FT/WSJ)
• Netflix released earnings this week after announcing an increase in their monthly price for consumers. This move is not unexpected given that the company continues to burn cash to fund TV shows and movies to fill out their library of content. Netflix is also gaining good traction with overseas subscribers (2nd chart).

• General Motors Co. said its largest restructuring since its 2009 bankruptcy will have a speedy impact on its bottom line. Cuts to its North American operations should boost operating profit in 2019 by nearly 20% ($2B). (WSJ)
• Elon Musk’s SpaceX plans to reduce its workforce by 10%, or roughly 600 employees, even as the company seeks to ramp up ambitious projects to develop a super-powerful rocket and deploy thousands of advanced satellites. The move is the latest sign of major strategic and technical challenges roiling the closely held Southern California company. (WSJ)
• The corporate bond market, now stands at over $9 trillion, according to the Securities Industry and Financial Markets Association (SIFMA). That’s a 64% increase from a decade ago when the Federal Reserve lowered interest rates to nearly zero. The size is not as important as the deteriorating credit quality of these companies which will exacerbate the next credit cycle. (Investopedia)

• Chinese vehicle sales fell last year for the first time since 1990 as economic uncertainty weighed on consumers. With the outlook still shaky, “there’s no evidence right now to suggest demand is coming back,” said Benjamin Lo, head of China autos research at Nomura Securities. Facing saturation elsewhere, global auto makers have banked on China, the world’s largest car market. General Motors and Volkswagen sell more vehicles in China than anywhere else. (WSJ)

• Taiwan Semiconductor Manufacturing, the world’s largest contract chipmaker, expects a sharp downturn in revenue growth in the first three months of 2019, in the latest sign of slowing smartphone demand and as a weak global economic outlook hits electronics suppliers.
• Global demand for aluminium is likely to grow this year at its slowest pace since the global recession of 2009, according to Alcoa, in the latest sign of a worldwide economic slowdown. 
• Ford will use a blockchain-based platform to trace supplies of cobalt from a Chinese-owned mine in the Congo for the batteries in its electric cars, in an attempt to ensure they are not linked to human rights abuses. The project is the latest effort to use blockchain to improve the transparency of global supply chains, especially in commodities.
• Tesla Inc said on Friday it was cutting several thousands of jobs, as the electric car maker looks to trim costs and be consistently profitable while it ramps up the production of its crucial Model 3 sedan. The company said it would reduce full-time employee headcount by about 7 percent and retain only the most critical temps and contractors. Earlier this month, Tesla cut U.S. prices for all its vehicles to offset lower green tax credits, and fell short on quarterly deliveries of its mass-market Model 3 sedan.

That is all for now. Please reach out to me if there is anything you want to discuss about the markets, your portfolio (for clients) or if you would like a copy of the firm’s brochure if you are not a client. 

Regards,

Paul J. McCarthy, III

President – Kisco Capital

paulmccarthy@kiscocap.com

(347) 709-9539