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.
The Kremlinologists turned out to be right, and the Federal Reserve left its “considerable time” language in its statement to assure the markets that it would be around for a while longer with rock bottom rates. It’s the divergent (to a point) reaction out of the markets themselves that is interesting to parse, and will be key to watch in coming weeks and months. The action in the stock market was to suggest the entire exercise was a snooze-fest, with stocks ending marginally higher (yes, the Dow at a new record) but not too far from where the major averages were trading just before the news. Which is to say the equity market, always the most optimistic of U.S. markets, has it in mind that low rates stay for now, and until “now” is “then,” it’s time to party.
Bond markets, inflation-protected securities and the currency markets saw things differently, and it’s those markets that may be more instructive to watch as the days and months go on and on. The five-year TIPS note saw its yield break above zero for the first time in ages, a sign that investors are starting to worry more about inflation, or higher Fed rates, which is interesting as consumer price data showed year-over-year inflation fall to a 1.7 percent rate earlier in the day. The dollar put together another strong rally, meanwhile, with the dollar index hitting highs not seen in 14 months and big rises against its main companions, the euro and the yen. And this is where the dot matrix comes in.
It’s all over but the dissection of the Fed statement, due later today, which will follow with a Janet Yellen press conference after the U.S. markets get word of whether the Fed did or did not eliminate the “considerable time” bit from its statement that saw markets go into a tizzy all of Tuesday. At this point the market believes that phrase now may *not* be eliminated, which marks the second reversal in about a week on this point. No matter what, somebody is going to be caught leaning in the wrong direction, but if the latest intelligence is that the Fed’s statement won’t change materially until the October meeting, then the freshest bets are probably in the direction of those betting on that much. So if the statement does cut out that language or modifies it in any way, you could see a selloff in equities, the dollar and bonds.
The meeting also brings with it the update on the Fed’s “central tendencies,” that is, its sure-to-be-incorrect projections on where the economy is going. Given the rebound in the second quarter that seems to have at least been somewhat sustained in the third quarter, it wouldn’t be surprising to see the Fed outlook for GDP bumped up for 2014 (currently 2.1 to 2.3 pct) and 2015 (at 3.0 to 3.2 pct – the Fed will predict 3 percent growth for the year-out period until we’re all Morlocks), and the unemployment rate expectations are projected to drop to maybe 5.7 to 5.8 percent from the current 6 to 6.1 percent expected at year-end. Which is all well and good, but it doesn’t give us a good sense, really, of what’s to happen going past the meeting.