Time and again, the Fed has provided stimulus to keep the stock markets afloat for many bumps in the economy over the last 10 years. Will they do it one more time? The REPO activity at the end of September caused the Fed to increase the size of their balance sheet (+$185B) which replicates the effects of Quantitative Easing (QE). On Friday, the Fed announced their emergency REPO activity would be extended until November 4th ($75B weekly) – this means there is something wrong with the overnight funding markets or the Fed is creating a backdoor way of re-starting QE (or both).
The byproduct of low interest rates is debt creation on all levels – consumer, corporate and sovereign. There is about $10T more in debt outstanding then at the height of the financial crisis in 2008 – a one-third increase.
More debt outstanding means corporate America is sliding towards below investment grade credit ratings. Corporations have used low interest rates to buy their own stock in lieu of investing in their future to grow revenue and profits. Over time, this activity begins to chip away at a company’s ability to re-pay its debt. Unfortunately, this dynamic eventually robs investors of owning safe assets in times of recession or economic uncertainty. In the chart below, a recession would largely shift most companies from the ‘BBB’ bucket to ‘BB’ (or lower). This scenario also implies a much higher risk of default whenever the next recession unfolds.
Are junk bond holders getting paid enough to hold this higher default risk? Not according to the chart below that shows a big disconnect between weakening manufacturing data and high-yield bond spreads. This sets up the corporate bond market for a swift tumble when the two converge in a weakening economy.
So what is the S&P 500 doing now? Not much as you can see over the last several months. Very choppy and not trending so the technicals have been frenetic. However, this week we filled two gaps in the chart and bounced hard off of the 200 day (blue line) to close out the week.
If we widen out the chart to when the Fed raised interest rates last year (October 2018) we can see that not much has happened in the past year, either – except for one slight new high and several whipsaws. Will the Fed capitulate one more time and and rescue the S&P 500 from this choppy range?
Chart of the Week!
If you watch stock charts for a living you can’t help but notice this chart looks like a parabolic stock about to make a large correction.
Economic & Central Banking Snippets
- China’s manufacturing sector shrank for a fifth month in September, government data showed on Monday, amid the effects of the ongoing China-US trade war. High-level talks between Washington and Beijing are set to resume in October. (FT)
- The Reserve Bank of Australia on Tuesday responded to falling interest rates globally by cutting its official benchmark rate for a third time this year to a record low of 0.75%. (WSJ)
- South Korea’s inflation slowed to a record low amid growing concerns about subdued price growth and a cooling economy. Declining exports amid continued global trade tensions has been stoking concerns about a possible recession. (WSJ)
- A central bank survey among Japan’s largest manufacturers deteriorated to the weakest level in more than six years amid growing trade tensions and the slowdown in China. The deterioration will likely add pressure to the Bank of Japan to ease monetary policy at their next meeting in late October. (WSJ)
- The September U.S. ISM manufacturing index fell further into contraction at 47.8 vs 49.1 in August which marks the weakest print since June 2009. The breadth of the weakness was broad as only 3 industries of 18 surveyed saw growth vs 9 in August. Now 15 industries are seeing an outright decline in business, up from 7 last month. Under the hood and in particular, there are ZERO industries that saw an increase in backlogs. (Boock)
- The September U.S. ISM services index fell to 52.6 from 56.4 in August. That is 2.4 pts below the estimate of 55 and the lowest print since August 2016. One participant said, “Costs are going up, from labor to chemicals to metals.” 15 of 18 industries said prices were rising vs 12 in August as someone has to eat the tariffs. (Boock)
- Europe’s economy may have ground to a halt. IHS Markit’s composite purchasing managers index, a measure of business activity, fell to the lowest level in more than six years as a manufacturing downturn showed signs of spreading into the broader economy. “The risk of recession is now very real,” said IHS Markit economist Chris Williamson. (WSJ)
- U.S. Employers added 136,000 jobs in September and the unemployment rate fell to the lowest in 50 years at 3.5%. Wage growth was flat, and rose 2.9% from a year earlier, down from a recent high of 3.4% in February. Revisions added 45,000 jobs to initial estimates for August and July. (WSJ)
- The bad, however, was that the average hourly workweek missed badly, and was unchanged from August (when it rose 0.4% sequentially), missing expectations of a 0.2% increase. On a Y/Y basis, earning grew 2.9%, far below the 3.2% in August, and also below the 3.2% expected. All this happened as the average weekly hours worked remained unchanged at 34.4
- Forever 21, the California retailer that helped popularize fast fashion in the United States with its bustling stores and $5 tops, filed for bankruptcy, a sign of the eroding power of shopping malls and the shifting tastes of young consumers. It will close up to 178 stores in the United States and up to 350 over all. (NYT)
- Saudi Arabia has boosted efforts to woo investors to the long-awaited stock market listing of Saudi Aramco by announcing an annual dividend of $75bn while scaling back global expansion plans at the oil company to increase cash flow. Riyadh is also planning to change state royalty payments and cut corporation tax as the kingdom pushes to secure a $2tn valuation for the state energy group. (FT)
- The latest development in consumer spending: Layaway for sweaters, makeup or other everyday items. Thousands of merchants, including Walmart, Urban Outfitters and soon H&M, are offering loans or other plans that allow payment in installments. Merchants are tapping into the financial challenges many U.S. families face, and the plans often resonate with young adults wary of carrying credit-card balances. (WSJ)
- A day after WeWork formally withdrew its IPO application, the Fitch ratings agency has downgraded the property company’s credit rating deeper into speculative territory The cut was two notches from B to CCC+, putting it in junk territory. (FT)
- More Americans are freelancing because they want to, not because they have to. A study for freelance jobs website Upwork and the Freelancers Union showed 60% of freelancers started working that way by choice, rather than by necessity, a 7% percent increase since 2014. Half of freelancers view their work as a long-term choice, instead of a temporary way to make money. (WSJ)
That is all for now until next week’s Market Update. Thank you for being a subscriber!
Paul J. McCarthy, III
President – Kisco Capital