Shanghai Surprise

We closed last week on a positive tone with equities poised to break higher but uncertainty around trade talks with China pushed stocks to work lower all week. It is clear after this week that the markets want a trade deal with China as tariffs will likely be a drag on economic activity. The tariffs are already causing problems evidenced by some farmers that are under duress as soybean exports are now closed to China while milk and pork exports have dropped. I would expect to see more releases from corporate America about the effects of the new tariffs in the coming weeks in particular the manufacturing sector. This leaves us in tariff limbo as this situation will not change anytime soon as both sides have exhausted this round of talks and are willing to take their ball and bat and go home. No deal.

Below is a list of sectors that are projected to be the most impacted by retaliatory tariffs by China:

What is the next catalyst for this market? The Fed has stopped raising rates, the yield curve inverted this year (bad) and earnings are not so great in comparison to 2018. A trade deal with China could have gone a long way for another leg up in stocks but that is off the table now. There are now several unknowns that arise with no-deal. For example, many semiconductor and cloud computing companies generate a significant amount of their revenues from China. What happens there?

The lack of catalysts means the market will be the news going forward – ignore all the tweets. In the chart below, we broke the wedge pattern on Monday and found support near the 50 day (magenta line) to close out the week. We have options expiration next week (usually bullish) so a little more corrective rally is to be expected in the coming sessions. Longer-term, stocks have not been tested in many months so this could be the start of a larger pullback.

S&P 500 Index

Chart of the Week!

On a side-note, the IPO market has been busy. Many of the private large-cap tech companies are using the rally from the December low to price their IPOs and get it done before the party is over. In particular, the UBER IPO priced on Friday but it went very badly. First, the size of the deal was huge as $8B in stock priced among an IPO market that prices deals on average under $500mm. There was also little support from instituions in a warning sign of an overpriced deal. The talk was $45-$50 but ended up pricing at $42 and closed the trading day at $41.51. It didn’t help that its main competitor, LYFT, is down 42% from its opening print in early April. I thought the chart below was interesting. What happens in a downturn when everyone stops going out for dinner?

Economic & Central Banking Snippets 

  • The Fed issued a financial stability report this week that recognized the size of the corporate debt market as being a risk to the economy. “Borrowing by businesses is historically high…with the most rapid increases in debt concentrated among the riskiest firms amid signs of deteriorating credit standards…Credit standards for new leveraged loans appear to have deteriorated further over the past six months…The historically high level of business debt and the recent concentration of debt growth among the riskiest firms could pose a risk to those firms and, potentially, their creditors.” Below is a chart of issuance by the CLO market by vintage which are securitiztions of high-yield loans. As you can see issuance continues to ramp up what you can’t see in the chart is that underwriting standards have fallen significantly in the past few years.
  • Taiwan’s exports fell 3.3% y/o/y which marks 6 months of y/o/y declines. (Boock Report)
  • New Zealand’s central bank cut its benchmark rate by 25 basis points to a record low on Wednesday, citing slow global economic growth and the need to support employment and boost inflation, prompting a sharp drop for the currency. The move is the first change in the benchmark rate since November 2016.

Macro Snippets

  • Kraft Heinz has warned it is restating almost three years’ worth of financial statements after uncovering evidence of “misconduct” among employees. The US food company, which previously said it had received a subpoena from the Securities and Exchange Commission into accounting in procurement, disclosed on Monday it needed to fix “errors” in previously issued accounts for 2016, 2017 and the first three quarters of 2018.
  • More than a decade after Congress set up a way to erase student debt for people who hold public-service jobs, the system is in disarray. More than 73,000 people have applied for debt forgiveness as of March 31 of this year, according to Education Department data, but just 864 have had their loans erased. (WSJ)
  • U.S. nearly triples its natural-gas exports to the EU since July. The rise marks a bright spot in trans-Atlantic relations marred by disagreements on issues ranging from trade to Iran’s nuclear deal. (WSJ)
  • This year is shaping up to be the biggest by far for defaults in China’s $13 trillion bond market, highlighting the widening fallout from the government’s campaign to rein in leverage. Companies defaulted on 39.2 billion yuan ($5.8 billion) of domestic bonds in the first four months of the year, some 3.4 times the total for the same period of 2018, according to data compiled by Bloomberg. (Bloomberg)
Defaults are rising in the Chinese debt markets.

That is all for now until next week’s Market Update. Thanks for being a reader and good luck out there navigating these markets!  


Paul J. McCarthy, III

President – Kisco Capital

Paul McCarthy

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