Waiting for Convergence

The stock market has held up well despite the rising risks to global supply chains because of the coronavirus. The number of cases has yet to show signs of a plateau and we await more information from companies that will likely need to warn on reduced earnings.

The S&P 500 is bumping into stiff resistance from a trend-line that originates from the 2009 low (blue line). The stock market has been running in an overbought condition despite the risks to global growth. We did get a weak close into Friday and it wouldn’t surprise me if the selling continues into next week. The Fed’s REPO program since October has ignited a buying spree in equities right into 2020 and the coronavirus. A larger correction could easily be at hand.

SPX: S&P 500 Index

One of the major divergences over the last several months has been the yield curve verses the S&P 500 as seen below. The 10Yr now yields lower than T-Bills and the 30Yr closed the week below 2% at 1.91%. The two lines in this chart should begin converging soon.

Also, the Fed minutes this week indicated a desire to end the overnight REPO lending program and we did see the size of the securities held by the Fed shrink by $11B. The last time the Fed tried to withdraw stimulus was October 2018 where the market proceeded to drop 20%. I don’t think they will pull that lever unless they feel the REPO program has grown far beyond their expectations, however.

This chart below shows their holdings in Treasuries (green) and mortgage backed securities (magenta). As you can see, the Fed was letting both portfolios run-off until the REPO operations caused the Fed to add $400B+ to their Treasury holdings. They may have painted themselves into a corner if global growth falls in 2020. Will they blink if the S&P 500 falls into correction territory?

Chart of the Week!

Economic & Central Banking Snippets 

  • Global trade was on track to weaken in the opening months of 2020 even before the coronavirus outbreak. The World Trade Organization’s (WTO) goods trade barometer for December suggests year-on-year trade growth may fall in the first quarter, weighed down by softening demand for air freight, electronics and raw materials. “It does not account for recent developments such as the outbreak of COVID-19, the new coronavirus disease, which may dampen trade prospects further,” the WTO said. (WSJ)
  • The US Manufacturing and Services Composite Index fell to 49.6 from 53.3 with a 4 pt drop in services to 49.4 and a 1.1 decline in manufacturing to 50.8. Outside of the 2013 government shutdown this is the 1st time this index is below 50 since 2008. “Total new orders fell for the first time in over a decade.
  • Japan’s manufacturing PMI fell to 47.6 in February, the 10th straight month in contraction territory and the weakest reading since December 2012. (Bloomberg)
  • Following a dismal final quarter of 2019, Japan’s economy is facing a recession because the coronavirus outbreak is hurting tourism and production. The world’s third-largest economy contracted at an annualized rate of 6.3% in the October-December quarter, pulled down by a sharp drop in private consumption after the national sales tax rose to 10% on Oct. 1 from 8%. (WSJ)
  • Housing starts in January totaled 1.567mm, well more than the estimate of 1.428mm. A mild winter has helped, particularly in the Northeast with multi-family properties.
  • The Producer Price Index (PPI) in January rose by .5% m/o/m and 2.1% y/o/y. Core goods prices were up by .3% m/o/m driven by a 14% spike in iron and steel scrap prices while services prices jumped by .7% with 40% of that coming from higher prices for apparel, jewelry, footwear and accessories retailing. (Boock Report)
  • The February composite Sales Managers Index (SMI) report from World Economics shows the extent of the coronavirus impact on China’s business activity. (WSJ)
  • The Cass Freight shipments index for January fell 9.4% y/o/y and they said “The turn of the calendar didn’t leave the bad news in 2019, as the Cass Freight Index showed continued weakness in the US freight market. Both the shipments and expenditures components of the Cass Freight Index worsened sequentially and showed decelerating y/o/y growth.” (Boock Report)

Macro Snippets

  • Companies across China are taking advantage of the coronavirus outbreak to shore up their balance sheets. More than 25 Chinese businesses, ranging from airlines to drug distributors, have raised Rmb24bn ($3.4bn) by selling “virus control” bonds since the start of February, according to Huatai Securities. (FT)
  • Macy’s credit rating was cut to junk status (BBB- to BB+) at S&P Global Ratings, two weeks after it unveiled a $1.5bn cost-cutting plan amid pressure to adapt to declining mall traffic and consumers’ growing appetite for online shopping. (FT)
  • Apple has warned that disruption in China from the coronavirus will cause its revenues to fall short in the current quarter, marking the second time in little over a year that weakness in China has forced the world’s most valuable technology company to issue a financial caution. (FT)
  • Samsung has begun flying electronic components for its latest Galaxy phones from China to its factories in Vietnam, where it produces nearly two-thirds of its phones. (FT)
  • Pier 1 Imports has filed for bankruptcy with plans to sell the company, less than two months after the troubled home-decor retailer said it planned to close up to 450 stores and cut costs to slow down its cash burn. (WSJ)
  • China is to begin importing live chickens from the US as feed shortages due to the coronavirus force poultry farms in the world’s second-biggest economy to start culling millions of young birds. The culling of poultry follows the mass slaughter of pigs in China due to African swine fever over the past year and threatens to worsen a protein shortage in the country that has sparked rising inflation and soaring meat prices.“ (FT)
  • China has banned Hubei residents from leaving their homes. One person per household will be allowed outside every 3 days to buy groceries and supplies. (SCMP News)
  • Desert locusts are wreaking havoc and threatening food security in East Africa. The Food and Agriculture Organization of the United Nations called the situation in Kenya, Ethiopia and Somalia “extremely alarming.” Moody’s said the infestations will add to inflationary pressures in vulnerable nations and fuel the potential for social unrest in the region. (Investopedia)

That is all for now and thank you for being a subscriber!


Paul J. McCarthy, III

President – Kisco Capital

Paul McCarthy

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