The preparation for tighter U.S. monetary policy is showing up in markets in a number of areas, most notably through the appreciation of the dollar which has a greater affect on GDP growth than people sometimes realize. Rising strength in the greenback, which would be expected to continue given the dovish monetary policies being pursued in Europe and Japan, turns into notable weakness in a number of U.S. sectors tied to exports like autos and energy.
Citigroup’s William Lee dives into this by pointing out that substantial rallies in the dollar have the power to brake GDP in a way that Fed tightening even doesn’t, saying GDP growth could decline by a percentage point if the rapid move in the dollar continues through early 2015.
As Abraham Simpson would put it, “that’s a job report you can set your watch to.” Overall growth came in a bit better than expected, with job growth at 248,000 and the unemployment rate dipping to 5.9 percent. There’s no wage growth, of course, because, well, it’s kind of an ongoing situation now, and the U-6 rate of underemployment fell to 11.8 percent, which is also overall strong news.
The market’s initial reaction is telling – bond markets are selling off, with more pain in the five to – and 10-year area of the curve, reflecting expectations for higher rates before long but not so much that you can really point to something that will derail economic growth. With futures higher, the thinking right now is that the market will manage to close out the week with a somewhat better tenor than it did coming into the week.
One day before the key jobs report that will likely paint yet another muddled picture of the current economic state, it’s the bond market that’s gotten more dynamic and interesting than the other asset classes out there. Treasuries are seeing a safe-haven bid on the back of Ebola and protests in Hong Kong, along with a comparison to the still-falling yields in the euro zone. High yield securities are seeing their spreads widen out in a way that’s commensurate with previous pullbacks that have later manifested into notable corrections in the stock market (and given the Russell 2000 hit that 10 percent threshold on Wednesday, the answer is yes, this is something to keep watching), and so that’s yet another bit to watch for as well.
Some of it can be explained by the sudden departure of a certain fixed income manager in California from the firm he founded a million or so years ago. And while there’s a heavy temptation to emulate Bill Gross here by somehow speaking this column out loud as if my rabbit had penned it, we’ll be content to note that the Treasury market’s selling pretty well snapped back in a couple of days.
One of the day’s biggest indicators will be monthly auto sales figures, at a time when the major U.S. automakers are seeing notable weakness in their equity prices. We’re waiting on insights from General Motors as they hold an analyst day and after Ford warned that its profits would fall short of expectations for 2014 and 2015 thanks to bigger recall costs in North America and bigger losses in South America and Russia. It’s tempting to go after the world weakness – be it Brazil, Russia, Germany or what-have-you – as that which ails the likes of a big automaker like Ford, and certainly the lackluster demand there isn’t going to help anybody.
But Ford in 2013 still counted 58 percent of its sales from the United States (Russia is de minimus now, not even warranting a percentage amount in its line items on its segment breakout). Germany accounts for about 6 percent, so there’s that – but still, U.S. Fifty-eight percent. Ford full-size pickups. Big margins, y’know? So the Detroit team (and investors) are looking for any kind of weakness there, anything that supports the idea that sales incentives are doing for car sales what the Fed has done for the bond market (that is, provide lots of financing) and whether transaction prices are rising or not.
Plenty of cross-currents to be aware of in the markets right now – many of which are pretty confusing and relate countervailing messages when it comes to where equities and other risky assets are headed. Stocks were heavy at the open on Monday and slowly got better throughout the day but energy stocks remained under pressure. The expectation of more unrest in Hong Kong certainly has contributed to the jitters, but the U.S. is a pretty resilient economy regardless of outside forces so it’s while it’s easy to blame China broadly, it’s hard to apply too much of a causation (probably why equities recovered throughout the day).
The bond market might be the better signal for the worries in equities. Last week speculators increased their short position in two-year notes to their longest since 2007, and asset managers hold their biggest short position in five-year notes since 2011; taken together that’s a clear sign of bearishness in the front end of the curve, reflecting expectations for a flattened yield curve as part of higher rates across the board. With the dollar continuing to strengthen, there’s a bearish sense in the air when it comes to U.S. central bank policy, and that’s something that again threatens to undermine equities — witness the weakness again in energy names.
These days things are all about canaries in coal mines – be it the small-cap names, the energy stocks, emerging markets or a handful of other important sectors that people hold up as a precursor to some sort of “big bad” event that comes down the line (and by big bad we mean like a boss level kind of thing, like Bowser from Super Mario Bros).
That said a correction wouldn’t be out of line right now – the market has gotten used to rolling corrections through a number of sectors throughout the year, and right now, it’s energy’s turn to take it on the chin, with stocks like Valero, Noble Energy, Ensco and Diamond Offshore among the worst performers in the S&P through September. They’ve been hit by a combination of factors – the dollar’s strength has sapped the price of oil dramatically in the last several weeks, and the ongoing fascination with the fracking boom has investors all a-buzz about the onshore drillers, so that’s hurt the offshore names (funny how that is).
The idea of increased political risk when it comes to the U.S. markets has been mined before, and it’s true that the uncertainty that surrounds debates such as the renewal of the Export-Import Bank’s charter and the growing expectation that Republicans, should they take power in November in the Senate, could force another confrontation over the debt ceiling. That said, political risk in the U.S. isn’t anything when compared with Brazil as the largest South American economy gears up for its presidential election, a contest between current president Dilma Rousseff and environmentalist Marina Silva, who until last month wasn’t even running (she was the vice presidential candidate for her party, whose original candidate was killed in a plane crash).
It’s an understatement to say the markets aren’t a fan of Rousseff, who hasn’t been able to bring the country out of its current economic rut – in fact, a chart of the Bovespa stock market makes it an easy one to pick out pivot points in the election race. In a two-week stretch following the death of Eduardo Campos, the Bovespa jumped more than 11 percent as investors started to see Silva as the candidate more likely to take out Rousseff (the other candidate, Aecio Neves, has seen his support slowly erode as Silva emerged as a popular choice).
In another sign of interesting times returning for markets, we’re seeing notable weakness in small-cap names and mixed performance in the emerging markets, the latter because of growth concerns out of China, the former probably more directly related to the expectations that monetary policy isn’t going to be anywhere near as friendly as it’s been in the past with the Fed ready to (finally) end QE3 in a month or so.
From its most recent high of 1179.47 the Russell 2000 has now lost 4.3 percent in an 11-day period, and if that’s extended further, it’s 6.5 percent since the end of June, so that’s a steady bit of air leaking from the balloon overall here. It’s not to say that this means the top has been achieved and we’re all downhill from here – the small-cap names are a more volatile bunch and there are plenty of examples of its underperformance not necessarily dooming the broader market overall.
The dollar is now running a 10-week streak of strengthening (using the dollar index, which is a basket of currencies but mostly the euro and yen), and while that streak will end at some point, the overall trend does not look likely to abate in the near-term. That presents some interesting opportunities in markets, trends that have already been playing out but are likely too to persist as investors concentrate more on companies less exposed to areas like Europe and more exposed to the United States.
The weakness in the euro eventually is going to undermine sales there from U.S. companies – even though the euro is still on balance stronger than the greenback, it’s threatening to continue to slip against the dollar, with Goldman Sachs strategists believing that it will eventually hit parity as the tendencies of the major central banks pass like ships in the night. For the year so far, Goldman’s basket of S&P stocks that are mostly exposed to the U.S. economy is up 13 percent on the year, with a 3 percent gain in the last month; its basket of companies exposed most to Western Europe is up 6 percent on the year, and flat on the month. What’s concerning is that the domestically-oriented names are sporting overall higher price-to-earnings ratios at 19 compared with 16 for the Europe group, and so these companies – the likes of Intuit, UnitedHealth and a few other major health insurers, a few brokerages, AT&T, and a bunch of others – could be overvalued. It’s also possible that the dominance by the health companies in that growing area is overwhelming any weakness in any of the other sectors.
Reading the tea leaves on what’s likely to happen with the debut of Alibaba Group Holdings isn’t an easy task given a few of the weird quirks of this IPO that come into play. Shares will start trading in an hour or so after the open of trading on the New York Stock Exchange, and while it’s tempting to think the various wrinkles that come with the stock will prevent it from being as volatile as first-day activity is in hot deals, it’s hard to see how it doesn’t turn out any other way than the usual crazy way.
The company has made a show of saying it wants most of the shares to end up allocated to the fewest of large shareholders possible – the big active managers (since index funds can’t get in there just yet) and sovereign wealth funds that see this as a long-term play to appreciate over a period of time. Fund managers are in the midst of finding out how well they did (and with about 40 institutions requesting $1 billion allocations on a $22 billion deal, a lot of people are going to walk away from the table hungry), and the dynamic it creates after the open is sure to create a lot of activity.