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Submitted by Bill Blain of Shard Capital

“Slain, after all man’s devices had failed, by the humblest things that God, in his wisdom, has put upon this earth””

After last week’s stock market ructions, my market spidey senses are tingling… https://morningporridge.com/stuff-im-watching

In the headlights this morning:

• Saudi Arabia: forget the IPO and worry about MbS threating an oil war if the West doesn’t let him murder whomever he doesn’t like. $100 by year end?
• Brexit: The next millennium bug? Very good interview on Andrew Marr show with head of Next outlined a no-deal will be less than optimal, but it won’t be a disaster. Lets get on with it.
• Germany: Merkel’s affiliate party takes a pasting in Bavaria. Who is out a job first? Merkel or May?
• Trumpland: It’s the Fed’s fault. “I know more about markets than anyone else..” Blahbity blah blah blah.. That man never ceases to amuse us.

Thought for the day: “It’s always about politics..”

Market Psychology

I’ve never met a stupid chief investment officer*, but market moves never cease to bemuse me. Market perceptions seldom reflect economic reality. The “group-think” that is the market’s collective mind doesn’t have the time to ponder the deeper implications of news and events – it spontaneously reacts to headlines. The group psychology of markets swings from profoundly fearful to over-exuberant in a heartbeat.

At the moment the mood remains profoundly negative – reflecting very scared traders. The stock market’s crash, the news flow, the IMF and others predicting a slowing global economy, Italy vs Brussels, Brexit – and its doom’n’gloom all round. A few bright spots of news, like Brazil, aren’t improving sentiment. The market believed we were doomed on Thursday and saved by Friday. This morning the coin flip says: “we’re all dead by Wednesday.” Risk-off then?

Contrarians believe the smart way to play these “End of the Worlds” scenarios is to put their buying boots on and start hoovering up the bargains. Sell when everyone else is buying. That’s a little too simplistic – but generally buying solid assets at distressed prices when the rest of the market is losing its head is the way to massive returns. The secret is…. Timing.

Never easy to get timing right. Is this a stock market correction before the beginning of the next leg even higher? I’ve talked to plenty of market participants who think it might be. However, many also believe we’re going higher because there is absolutely nothing else to do with money when bond yields are heading higher and stock dividends continue to look attractive. These guys believe at some point soon – which will be when bond rates stop rising and global recession becomes apparent – then the stock market is set for an absolute thumping – the Global Stock Market reset.

Global Market Reset?

The inherent danger of a reset makes sense to me. The reason stock markets are so high might be due to expectations of higher corporate earnings, but I reckon it’s got more to do with the unintended consequences of QE; flooding markets with liquidity and forcing yield tourists out of bonds and into the equity markets. Ultra-artificially-Low interest rates have allowed corporates to borrow trillions. Have they spent it on new factories or creating new jobs? Nope.. the cash was used for stock buy-backs which inflate executive bonuses, or to leverage up private equity by converting equity into debt.. which again benefits the few – the owners!

Debt, lest we forget, is vital to growth, but not necessarily a good thing when overdone. Despite rising interest rates, the number of market comments, blogs and articles suggesting bonds look good value here is surprising. Good luck to them… 

Volatility is not the threat

The key issue today is not to fear the current volatility but how to play it. Volatility is opportunity! If stock and markets are just volatile… what’s the big threat? Total Market dislocation? If things are set to turn really bad – maybe the right trade is to shift out of risk ad into.. US Treasuries?? If something happens.. then Treasuries will be bid-only.

If (and triple underline if) we are now poised at the end of the bond correction and stock markets look overbought… that spells opportunity. Clue: Stocks are far easier to exit than bonds.

The really frightening threat is what happens if everyone decided to take risk off the table?

Liquidity gridlock. What happens if/when the market discovers liquidity is a hollow god?

Liquidity will be the murder weapon

The last crisis – 10-years ago – taught us diminished liquidity triggers runs on banks while a complete absence kills them. What’s happened since Lehman’s demise has been a massive transfer of risk from the banking sector – which means, so the regulators tell us, that banks are now safer. Marvellous. Where did that risk go? Into the non-bank financial sector.

I suspect the Buy-Side (by which I mean funds, pension providers, insurers, credit and hedge funds, equity players, etc) are about to discover that Liquidity Risk cuts all ways when it comes to de-risking when they try to sell illiquid assets – especially in the bond market.

Risk transfer from banks to investors is yet another unintended consequence of the reaction to the last financial crisis – banks were the vector last time, so new capital regulation and investment rules means we now we face yet another classic “wake up and smell the coffee” moment as funds discover their asset valuations bear no relation to reality. Why? Because 10-year of bureaucratic handcuffing of the market’s invisible hand thru regulatory overkill means they are less liquid than ever before.

The regulators are waking up to what they’ve done – placing high quality assets like property into high-risk buckets because of their illiquidity (and as an unintended consequence making such assets even less liquid!)

Meanwhile, markets are already massively distorted by the price-bending effects of QE on asset prices. You’ve got a whole market of buy-side investors who think liquidity and government largesse is unlimited, while the sell-side are muzzled by capital rules, MiFid, and all the other tosh. All these things together – successive waves of market distortion – are likely to trigger the RESET moment and the liquidity gridlock? That’s the moment cracks in the ice become holes…

Try it. Go ask for a bid for that bank capital bond you’ve got marked on your book at 100.00. If you are lucky, you might get a distressed bid back in the low 90s. Think about the Fund that’s seen massive client redemptions force it to sell portfolios of pristine assets at “distressed seller” prices. Try to sell some European Hi-Yield.. ouch. Again.. a distressed bid is the best you can hope for. Or how about Italian govies.. When you struggle to find a bid for Europe third largest economy… that’s a problem.

Treasuries might look awfully unattractive at the moment, but if a crunch comes then the flight to quality will be the most powerful market move in years. The problem for most investors is being stuck with hi-yielding illiquid assets, and being too late to move out of them..

The global financial crisis that began in 2007 taught us perfectly solid and safe assets could only generate distressed firesales prices. Same thing is going to happen this/next time. If you are in the happy position of being long cash, there will be bargains galore if/when crisis hits. At that point liquidity fearful holders will remember the old Blain market mantra: “A bid is a bid is a bid, and you should hit it harder and faster the proverbial red-headed step-child.”

(And extra points for anyone who doesn’t need to google this morning’s quote…” A lesson in not ignoring the simple and small stuff, or assuming anything about liquidity!)

Meanwhile, what about other stuff?

Europe?

Three questions about Europe:

What happens in May? (as in next year, rather than within our PM’s head.) The whole of the current European Empire is in switch around. New European parliament elections (which approve all EU rules) could see populists elected to a majority of seats creating legislative gridlock, include trade agreements in the post Brexit world. And we are into new ECB discussions – who will run the world’s most powerful central bank? What are the implications.

Who will win the trade war?

China has historically been misunderstood. The government works by delivering a stable society and get rich social contract to the non electorate. The US works by delivering growth and wealth to voters. Painful as it is to say.. Trump is delivering. Despite growth and wealth China will lose – forcing Xi to climbdown. Which model survives?

What else I’m watching: – press link to get a list of “interesting news stories..” https://morningporridge.com/stuff-im-watching

Back to the new day job!

(*actually…. I have, but not going to name the guilty…)

via RSS https://ift.tt/2NGnSpd Tyler Durden

As the mystery, and blowback, over the fate of missing Washington Post columnist Jamal Khashoggi grows, moments ago president Trump tweeted that he has spoken to the King of Saudi Arabia “who denies any knowledge of whatever may have happened to our Saudi Arabian citizen.” According to Trump, the King also said that “they are working closely with Turkey to find answer” and added that he is “immediately sending” Secretary of State Mike Pompeo “to meet with King.”

Just spoke to the King of Saudi Arabia who denies any knowledge of whatever may have happened “to our Saudi Arabian citizen.” He said that they are working closely with Turkey to find answer. I am immediately sending our Secretary of State to meet with King!

— Donald J. Trump (@realDonaldTrump) October 15, 2018

Trump’s tweet follows an escalation in rhetoric in which the president threatened Saudi Arabia with severe punishment if it is found that the Saudis were involved in Khashoggi disappearance and/or death, sending Saudi stocks plunging the most since 2016.

In response, Riyadh made a not so veiled threat to use the kingdom’s oil wealth as a political weapon – something which Bloomberg said was “unheard of since the 1973 Arab embargo that triggered the first oil crisis.”

On Sunday, Saudi Arabia said on Sunday it would retaliate against any punitive measures linked to the disappearance of Washington Post columnist Jamal Khashoggi with even “stronger ones.” In an implicit reference to the kingdom’s petroleum wealth, the statement noted the Saudi economy “has an influential and vital role in the global economy.”

Additionally, the fact that the Arabiya article was published only minutes after Saudi Arabia’s press release was issued led many to conclude it was either a message conveyed outside diplomatic channels or a trial balloon that quickly went flat.

Roger Diwan, a longstanding OPEC watcher at consultant IHS Markit Ltd., said the Saudi comments broke “an essential oil market taboo.”

While few think that Saudi Arabia is prepared to follow through, even the suggestion of using oil as a weapon undermines Riyadh’s long-standing effort to project itself as a force for economic stability. Jeffrey Currie, the head of commodities research at Goldman Sachs Inc., said Middle East tensions impacting the oil market have now “broadened to include Saudi Arabia.”

The tensions were exacerbated by an article written by Turki Al Dakhil, who heads the state-owned Arabiya news network and is close to the Royal Court, in which he openly talked about using oil as a weapon.

“If President Trump was angered by $80 oil, nobody should rule out the price jumping to $100 and $200 a barrel or maybe double that figure.”

As we noted overnight, the Saudi embassy in Washington later said Al Dakhil didn’t represent the official position of the kingdom and Saudi officials, speaking privately, said there wasn’t a change in the long-held policy that oil and politics don’t mix.

In an attempt to further defuse the tense situation, on Monday, Khalid Al-Falih, the Saudi energy minister pledging his country will continue to be a responsible actor and keep oil markets stable, during a speech in India.

“I want to assure markets and petroleum consumers around the world that we want to continue support the growth of the global economy, the prosperity of consumers around the world,” Al Falih said.

On Sunda, Saudi Arabia said it’s begun an internal investigation into the disappearance Khashoggi at its Istanbul consulate and could hold people accountable if the evidence warrants it.

Still, concerns about a potential retaliation by Riyadh using its oil output have spooked markets, with oil jumping in overnight trading.

To be sure, Riyadh could easily bring the global economy to its knees in the short-term by cutting output and sending prices sharply up, something we noted on Sunday afternoon as the kingdom pumps one-in-ten oil barrels produced worldwide, and holds nearly all the spare capacity available to respond to any supply outage.

Saudi response to Trump:

Did we say we will pump 10.7mmb/d? Silly decimal comma typo: we meant 1.07mmb/d

— zerohedge (@zerohedge) October 14, 2018

Even just hinting that it won’t replace the barrels lost from Iran due to U.S. sanctions could be enough to push prices toward $100 a barrel.

But if the Saudis retaliate using oil, it would lead to “calamity,” said Stephen Innes, Singapore-based head of Asia Pacific trading at Oanda Corp. “This would be so destabilizing for global markets that it would make the current trade tensions between the U.S. and China look like a game of Axis & Allies.”

As a reminder, the last direction confrontation between Saudi Arabia and the US, namely the 1973-74 embargo, and the second oil crisis in 1979, destroyed oil demand for ever as industrialized countries taxed gasoline and diesel and embarked on conservation policies. Oil consumption is lower today than in 1974 in Germany, Japan, France, Italy and the United Kingdom.

via RSS https://ift.tt/2Abrqw8 Tyler Durden

Authored by Michael Snyder via The Economic Collapse blog,

It looks like it could be another tough week for global financial markets.  As the week began, markets were down all over the world, and relations between the United States and Saudi Arabia have taken a sudden turn for the worse.  That could potentially mean much, much higher oil prices, and needless to say that would be a very bad thing for the U.S. economy. 

It has really surprised many of us how dramatically events have begun to accelerate here in the month of October, and the mood on Wall Street has taken a decidedly negative turn.  Yes, U.S. stocks did bounce back a bit on Friday (as I correctly anticipated), but it was much less of a bounce than many investors were hoping for.  And this week got off to a rough start with all of the major markets in Asia down significantly…

In the Greater China region, the Hang Seng index in Hong Kong fell by around 0.9 percent in early trade. The Shanghai composite also slipped by 0.33 percent while the Shenzhen composite bucked the overall trend to edge up by 0.4 percent.

In Japan, the Nikkei 225 fell by 1.48 percent in morning trade, while the Topix index slipped by 1.17 percent, with most sectors trending lower.

But what happened in Asia was nothing compared to what we witnessed in Saudi Arabia.

At one point the stock market in Saudi Arabia had plummeted 7 percent after news broke that President Trump warned that the Saudis could face “severe punishment” for the disappearance of journalist Jamal Khashoggi.

The Saudis are denying doing anything wrong, but everyone agrees that he is missing, and everyone agrees that he was last spotted entering the Saudi Consulate in Istanbul on October 2nd.

And it is being reported that U.S. intelligence had previously intercepted communications which indicated that the Saudis planned to abduct Khashoggi.

It is believed that Khashoggi was dismembered after being abducted by the Saudis, and all of the major western powers have expressed major concern about his fate.  But the Saudis insist that they didn’t have anything to do with his disappearance, and they are threatening “greater action” if any sanctions are imposed upon them.  The following comes from USA Today…

Saudi Arabia denied any involvement in the disappearance of Washington Post contributing journalist Jamal Khashoggi and warned Sunday that any sanctions against the oil-rich kingdom would be met with “greater action” and possibly exploding oil prices.

“The kingdom affirms its total rejection of any threats and attempts to undermine it, whether by threatening to impose economic sanctions, using political pressures or repeating false accusations,” the government said  in a statement released to Saudi media. “The Kingdom also affirms that if it receives any action, it will respond with greater action.”

So what might that “greater action” look like?

Well, one Saudi official is warning that the price of oil could rise to “$100, or $200, or even double that figure”…

In a column published just after the SPA statement, Saudi-owned Al Arabiya channel’s General Manager Turki Aldakhil warned that imposing sanctions on the world’s largest oil exporter could spark global economic disaster.

“It would lead to Saudi Arabia’s failure to commit to producing 7.5 million barrels. If the price of oil reaching $80 angered President Trump, no one should rule out the price jumping to $100, or $200, or even double that figure,” he wrote.

If the price of oil did shoot up to $200 a barrel, that would be absolutely crippling for the U.S. economy.

You see, it wouldn’t just cost a whole lot more to fill up your gas tank.  Virtually everything that we buy has to be transported vast distances, and so the price of gasoline must be factored into all of those products.

The price of food is already ridiculously high, and so I don’t even want to imagine what a trip to the grocery store might look like if the Saudis follow through on their threats.

Meanwhile, warnings from the mainstream media of a new crisis on Wall Street continue to become even more dramatic.  For example, the following comes from a Bloomberg article entitled “The Next Financial Crisis Is Staring Us in the Face”…

The financial crisis ripped through Wall Street 10 years ago, pushing the global economy to the edge of the abyss. One might think those searing experiences would have created a learning opportunity — for managing risk better, understanding structural imbalances in the financial markets, even learning a bit about how our own cognitive processes malfunction.

Instead, we have little new wisdom or self-awareness to show for that traumatic event.

And this is how that Bloomberg article ended…

As memories of the crisis fade as the economy recovers, we find the seeds of the next crisis are already being planted. They are the exact same issues of debt and mismanaging risk and not understanding our own limitations. Failing to learn from our prior experiences, we seem doomed to repeat them. We only have ourselves to blame.

That sounds like it could have been ripped right out of The Economic Collapse Blog.

Of course the author of that Bloomberg article is right on the money.  We never learned the very hard lessons that we should have learned from the crisis of 2008.  Instead, we simply reinflated all of the old bubbles and made them bigger than ever before.

Now America is 68 trillion dollars in debt, and our day of reckoning is so close that even the mainstream media is sounding the alarm.

It should be another very interesting week.  Monday may set the tone for the entire week, and so hopefully U.S. markets will bounce back some more.  If they don’t, it could set off another round of panic…

via RSS https://ift.tt/2NGlXRx Tyler Durden

After a disappointing slowdown in August, retail sales were expected to rebound in September but rather dramatically missed with headline data rising just 0.1% MoM (against expectations of a 0.6% rise).

 

However, while the “control group” beat expectations – rising 0.5% MoM (vs +0.4% exp), retail sales ex-Autos retail sales actually dropped in September by 0.1%, the biggest drop since May 2017…

Under the hood, 10 segments saw higher sales, 3 were lower…

Gas station spending dropped (likely price related), health and personal care stores also weakened, but the biggest drop was for restaurants spending, down 1.8% – the most since 2016 (which is being blamed on the Hurricanes)… shopping and consumer activities such as restaurant visits may have been affected in North Carolina and South Carolina in the aftermath of Florence, which made landfall on Sept. 14. At the same time, past experience indicates any negative fallout tends to be temporary and reverses in subsequent months.

So much for the exuberant consumer?

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Refusing to be cowed by a flurry of cancellations that have effectively gutted Riyadh’s Future Investment Initiative – colloquially known as “Davos in the Desert” – Saudi Arabia has lashed out at the US and its Western allies, warning that there will be hell to pay if anybody dares sanction the world’s largest oil exporter. If Mr. Trump is bothered by oil prices at $80 a barrel, the Saudis have wagered, imagine how uncomfortable he would be with oil at $200 a barrel? Already, oil traders have recognized Saudi’s “weaponization” of OPEC’s ability to control global oil supplies, while Saudi’s Tadawul stock exchange plunged 8% at the lows on Sunday (though this drop was mitigated in part by a late-session rebound).

But the tentacles of capital emanating out of Riyadh stretch across the world, to Tokyo and San Francisco and beyond, what one NYT op-ed writer described as Silicon Valley’s “Saudi Arabia problem.” And nowhere is this link more evident than with Tokyo-traded Softbank, whose shares have born the brunt of investors’ indignation over the burgeoning diplomatic crisis (a crisis rooted in Saudi Arabia’s suspected murder of a former-insider-turned-dissident-journalist inside the Saudi consulate in Istanbul). Softbank shares closed more than 7.3% lower on Monday in Tokyo, a move that analysts partly attributed to the instability surrounding Saudi Arabia. Since Softbank’s September peak, the company has shed more than $22 billion in market capitalization, according to BBG data.

A pullback in tech shares like Nvidia, in which Softbank owns a major stake, has helped weigh on Softbank shares as one BBG columnist calculated that SB’s Nvidia stake was “the major factor” driving Softbank’s profitability last year.

Just like the broader market, the pullback in tech was inspired, at least in part, by anxieties surrounding the US-China trade war. But its Saudi ties are increasingly becoming an intolerable risk in the eyes of investors.

Saudi Arabia, which has denied any wrongdoing, is the biggest outside investor in SoftBank’s $100 billion Vision Fund and is coming under increasing international pressure over the incident. Executives, including the head of JPMorgan Chase & Co., have pulled out of a high profile summit in the country and the U.S. is weighing action against the country over the disappearance.

But the danger for Softbank has nothing to do with whether Saudi Arabia will face international sanctions over the incident (indeed it most certainly won’t, as President Trump has already made clear). The real risk is that other investors in Softbank’s Vision Fund will begin pulling their money, potentially forcing a liquidity crisis as the company remains heavily invested in several private companies.

“We are not liking how Softbank has been trading and have decided to remove it from our recommended longs,” Amir Anvarzadeh, a senior strategist with Asymmetric Advisors in Singapore, wrote in a research note Monday. “Although we don’t expect this latest diplomatic incident to lead to any sanctions on Saudi, there is always some possibility that some firms will pull out their money from the Vision Fund.”

“We are starting to worry about other more likely scenarios that could prove as disruptive to Son’s plans,” he wrote. “Firstly and most importantly, we believe tech names will remain under selling pressure leaving Vision Fund’s paper profits on names like Nvidia (NVDA) vulnerable to big under-performance relative to the fund’s targets.”

Still, some fund managers have dismissed Monday’s Softbank selloff as “psychological” in nature, suggesting that this could be a good time to buy, per Reuters.

With SoftBank’s Saudi ties causing jitters, the share sell-off is “more psychological than anything related to worries on its fundamentals,” said Makoto Kikuchi, chief executive of Myojo Asset Management.

While Uber CEO Dara Khosrowshahi has already said he won’t attend the FII (Softbank owns a major stake in Uber, alongside the Saudi sovereign wealthy fund), a SoftBank has refused to comment on whether its executives would attend the event. Masayoshi Son, Vision Fund chief Rajeev Misra and ARM Holdings CEO Simon Segars had been listed as attendees on a conference webpage that is no longer available. Meanwhile, US luminaries including JP Morgan CEO Jamie Dimon, BlackRock’s Larry Fink and Blackstone’s Stephen Schwarzman have all said they won’t attend.

And as Reuters added, SB’s ties to Saudi stretch beyond the kingdom’s investments.

Ties to the Gulf Kingdom extend beyond tech investment. SoftBank and Saudi Arabia said in March they would build the world’s biggest solar power generation project.

The kingdom has appointed Son as an advisor for its planned $500 billion NEOM high-tech city, and in October last year, it said it was considering selling a large stake in Saudi Electricity Co to the Vision Fund.

As US lawmakers step up their demands to sanction Saudi Arabia, or at least roll back arms sales, expect the controversy to continue weighing on markets as companies with secondary and tertiary connections to Saudi money start feeling the sting. Meanwhile, as Saudi’s Gulf neighbors have expressed their solidarity with the Kingdom, the risks that an oil-price shock could reverberate throughout markets will only increase. 

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In what we are sure will likely engender a tweet response from President Trump, potential 2020 Democrat presidential nominee, Senator Elizabeth Warren proudly released results of a DNA test that suggests she does have a distant Native American ancestor in her lineage.

In the face of President Trump’s (and many others) doubts about her lineage, Warren, nicknamed ‘Pocahantas’ decide to seek the help of Stanford University professor and DNA expert Carlos Bustamente and later tweeted a clip explaining the results:

“My family (including Fox News-watchers) sat together and talked about what they think of @realDonaldTrump’s attacks on our heritage. And yes, a famous geneticist analyzed my DNA and concluded that it contains Native American ancestry.”

My family (including Fox News-watchers) sat together and talked about what they think of @realDonaldTrump’s attacks on our heritage. And yes, a famous geneticist analyzed my DNA and concluded that it contains Native American ancestry. pic.twitter.com/r3SNzP22f8

— Elizabeth Warren (@elizabethforma) October 15, 2018

The test found “strong evidence” she had a Native American in her family tree dating six to 10 generations back, the Globe reported.

“I’m not enrolled in a tribe and only tribes determine tribal citizenship. I understand and respect that distinction but my family history is my family history,” Warren said in a video explaining the results posted to her Twitter account.

“Trump can say whatever he wants about me, but mocking Native Americans or any group in order to try and get at me? That’s not what America stands for.”

Warren said this summer that she’s not yet decided to run for president and is focused on winning re-election to the Senate in the November midterm elections, and as Bloomberg reports, a CNN poll released Sunday found her running fourth in the list of potential Democrats with support from 8 percent of those listed. Former Vice President Joe Biden lead the poll with support from 33 percent of respondents.

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Submitted by Bilal Hafeez, macro strategist at Nomura

Over the weekend, we saw the CSU suffer in Bavarian state elections as it lost its absolute majority, though it still won the biggest share of votes (see bar chart).

Large gains were made on the left by the Green Party (who came second) and on the right by the AfD (who came fourth and now enter the State parliament). The Social Democrats (SPD) were the biggest losers, which continues the trend from the Federal elections in 2017. Current political calculus suggests a coalition between the CSU and the Free Voters, who came third. The Free Voters are made up from many former CSU politicians and position themselves as a protest party and in favour of rural and local issues.

One takeaway is that the trend away from establishment parties continues in Europe. Another is that local and national interests are dominating over international interests (a potential negative for EU-Italy negotiations). The bigger question for the macro community is what this means for Chancellor Merkel, the relationship between the CDU and CSU and the dynamics within the grand coalition with the SPD. At one level, the CSU has been critical of Merkel, and the weekend’s results could provide a boost for her. However, we get the next state elections on 28 October (Hessen), where the CDU will stand, and if the results are poor there, then this could bring renewed pressure on her. As for the grand coalition,  given the heavy losses faced by the SPD, it will need to consider whether remaining a coalition partner still makes sense.

A potentially negative course for markets would be for the coalition to break down and new elections to be called. As a reminder, the euro fared poorly after the inconclusive election results of the 2017 Federal elections and during the initial coalition talks with the FDP and Greens (see chart). So far the euro has fared well today, but we need to keep a close eye on developments and need to add Germany to our growing worry list (US stocks, Fed hikes, US-China trade/tech war, Italy, Brexit…).

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Following in the footsteps of JPMorgan on Friday, moments ago Bank of America reported revenue and earnings that beat expectations, with $22.8BN and $0.66 in Q3 revenue and EPS, both above consensus estimates of $22.67BN and $0.62, even as the bank missed on trading, reporting Q3 trading revenue of $3.1BN, below the $3.15BN expected, as equities generated $1.0BN (exp. $1.06BN) while FICC brought in $2.1BN, just above the $2.08BN expected.

Just like Jamie Dimon before him, BofA CEO has upbeat comments about the economy,  noting “… a solid U.S. economy and a healthy U.S. consumer.” Indeed, as shown below, consumer lending grew by 6% while the net charge-off ratio was at its lowest in nearly 10 years amid improvement in consumer real estate and energy loan performance, a continuation of the trend observed last week from JPMorgan, Citi and Wells.

Among the other highlights from the quarter, return on average equity was 11%; return on average assets 1.23%; Basel III common equity Tier 1 ratio fully phased-in, advanced approach 11.4%, estimate 11.4%; provision for credit losses $700 million, estimate $969.1 million.

Net interest income disappointed, up 6% to $11.9 billion ($12.0BN on a fully-taxable basis), the highest since 2011, but just shy of consensus estimates which was looking for $12.05 billion for the quarter. The net interest yield of 2.42% increased 6 bps from 3Q17, reflecting the benefits from spread improvement, partially offset by the impact of an increase in lower-yielding Global Markets assets. Excluding Global Markets, the net interest yield was 2.96%, up 13 bps from 3Q17. On the other hand, BofA said it remain positioned for NII to benefit as rates move higher, and disclosed that a +100 bps parallel shift in interest rate yield curve is estimated to benefit NII by $2.9B over the next 12 months, driven primarily by sensitivity to short-end interest rates.

The modest NIM weakness was offset by BofA’s decline in provision for credit losses, which was down $118MM, at $716MM, below last year’s $834MM and also below the $969MM expected by analysts. The decline echoes the trend observed at both JPM, Citi and Wells Fargo last week.

Looking deeper into BofA’s balance sheet, the allowance for loan and lease losses of $9.7B, represented 1.05% of total loans and leases. Nonperforming loans (NPLs) decreased $743MM from 2Q18, driven by improvements in both consumer and commercial. Commercial reservable criticized utilized exposure decreased $760MM from 2Q18.

While the quality of the balance sheet generally improved, BofA posted a modest decline in Loans and Leases, which declined from $935MM to $931MM sequentially into Q3, while Loans in Business Segments declined by $1MM sequentially.

Meanwhile, deposits continued to rise across Consumer Banking and Global Banking, but declined modestly in wealth management.

On the expense side of things, non-interest expenses were down about 2% to $13.1 billion during the quarter “due to broad-based improvements in both personnel and non-personnel expense.” As Bloomberg reminds us, BofA is targeting $53 billion in expenses for the year and it was on track to reach that goal as of the second quarter. Additionally, BofA’s efficiency ratio improved to 57% in 3Q18; total headcount of 205K declined 2% from 3Q17, reflecting declines in non-sales professionals as well as continued investments in primary sales professionals across Consumer Banking, GWIM and Global Banking.

Bank of America also highlighted that it has opened 53 new branches and renovated 404 others in the last year. Still, the number of branches overall is down 130 to 4,385 over the past year.

Looking at BofA’s trading performance in Q3, it was a somewhat mixed picture, with total sales and trading revenue of $3.1BN, (ex. net DVA) down 3% from a year ago, and missing consensus estimates of $3.15BN as equities generated $1.0BN (exp. $1.06BN), down 3% Y/Y, while FICC brought in $2.1BN, down 5% Y/Y and just above the $2.08BN expected. 3Q Investment Banking Revenue of $1.20BN also missed the estimate of $1.33BN.

Explaining the decline, BofA said that the 5% drop in FICC was due primarily to lower client activity in rates products as well as a weaker environment for municipal bonds. Meanwhile, equity revenue increase of 3% was driven by increased client activity in financing.

BofA’s IB revenue downtick seems to have come in worse than expected. Decline being mainly pinned on M&A advisory fees and leveraged finance. Equity underwriting was a bit of a bright spot. What analysts didn’t really expect was how bad debt-underwriting revenue would be: $684 million, compared with an average estimate of $820 million.

That said, as Bloomberg reminds us, this was the quarter that BofA said investment-banking head Christian Meissner is departing, and there have been rumblings about a lot of movement in the senior ranks. Still, the $1.25 billion in IB revenue is a good bit below the average estimate of $1.33 billion.

In consumer banking, BofA like other banks, was hit by rising rates and noninterest income decreased modestly, as higher card income and service charges were more than offset by lower mortgage banking income.

Looking at BofA’s results overall, it was another solid quarter in line with other banks, with the unexpected decline in credit loss provisions indicating optimism about the future even in a time of rising rates, while the miss in trading results will be largely forgiven as it was in line with what other banks reported. The stock was down initially on the results but has since bounced back.

Full earnings supplement below (link)

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Last week’s global stock rout returned despite Friday’s tentative bounce, as the selloff resumed in Asia with China tumbling 1.5%, closing at a fresh 4 year low, dragging European shares lower with S&P futures sliding 0.5% and Nasdaq futs down -0.8% on Monday, as a new diplomatic crisis between the US and Saudi Arabia added to a list of investor concerns and drove up oil prices. Safe havens bounced, led by Gold with Treasuries and the yen also rising.

“The breakdown in Brexit talks, the disappearance of dissident Saudi journalist Jamal Khashoggi, the demise of the CSU in Bavarian elections, the impasse over Italy’s budget and the worried tone coming from the IMF/World Bank meeting in Bali all combine to give financial markets an uncomfortable feel this morning,” according to SocGen FX strategist Kit Juckes.

A renewed threat by Trump to impose more sanctions on Beijing overpowered encouraging words from China’s securities regulator, accelerating the $3 trillion rout in China’s stock market, while evidence of weakening domestic demand added to concern about the trade war with the U.S. The Shanghai Composite Index fell 1.5%, closing at session lows and the lowest level in the index since November 2014 following a weekend of warnings on global economic fragility from finance chiefs meeting at an annual IMF gathering.

Over the weekend, President Trump threatened to impose another round of tariffs on China in an interview with CBS’s “60 Minutes” that aired Sunday. When asked whether he wants to push China’s economy into a depression, Trump said “no.” Also over the weekend, at the IMF annual meetings in Bali, finance officials weighed tremors rattling the global economy, from stock sell-offs to trade concerns and rising U.S. rates.

The Shanghai Composite has slumped 19% in the past six months and is in a bear market since its January highs as trade tensions increased and data signaled a slowdown in the economy, while the yuan has fallen more than 9%. A gauge of consumer-related shares dropped the most after data showed purchases of passenger vehicles and online appliance sales slumped in September. Liu Shiyu, chairman of the China Securities Regulatory Commission, said the country will deepen capital market reforms and press ahead with opening up after he met with investors.

The subindex of consumer discretionary stocks fell 2.1%, the most among the CSI 300 Index’s 10 industry groups. Great Wall Motor Co. slumped 9.4 percent to its lowest since 2012, while Qingdao Haier Co. tumbled 9.2 percent.

“The fundamental issues that haunt investors — lower global risk appetite and a slowing Chinese economy — remain,” said Ken Chen, Shanghai-based analyst with KGI Securities Co. “The market will only recover if those concerns are resolved, and it’s going to take more than just verbal promises.”

The Hang Seng Index fell 1.4% after three weeks of losses, while the Hang Seng China Enterprises Index dropped 1.5%. Tencent Holdings Ltd. slumped 1.9%. As we reported last week, purchases of passenger vehicles by Chinese dealerships plunged for a third straight month in September, dropping the most on record.

Over the weekend, Steven Mnuchin expressed concerns about the yuan’s weakness and called for a currency clause that would prevent competitive devaluations to be included in any trade talks with Japan. Separately, China’s ambassador to the U.S. said Beijing has no choice but to respond to what he described as a trade war started by the U.S.

Asian weakness spread to Europe, where industrial goods makers and technology firms were the biggest losers in the Stoxx Europe 600 index. In Frankfurt, stock trading has resumed after the opening was delayed by a technical glitch. Main European Indices are mixed amid current market uncertainty; the Dax is up (+0.3%) despite being weighed on by Lufthansa which is down by over 3% following agreements on new employment conditions, featuring moderate salary increases. Sectors are mixed with IT lagging at -1% as a follow on from poor IT performance in Asia due to continued U.S-China tension; this is despite Friday’s Wall Street rebound for IT which saw it as the leading sector finishing up by 3%. Convatec shares tumbled over 25% following a cut in revenue guidance.

The Bloomberg Dollar Spot Index slipped while Treasuries climbed amid the risk-averse mood. Most Asian currencies fell against the dollar, led by the Indian rupee and South Korean won as the rebound in global equities Friday failed to follow through after the weekend IMF gathering.  The British pound was volatile, paring a drop of as much as 0.5% after the U.K. and the European Union remained on course to miss this week’s key milestone on the road to a Brexit deal after talks broke up in stalemate on Sunday. The yen pushed higher while gold headed toward its fourth advance in five days.

Italian bonds erased earlier gains as the nation prepares to meet Monday’s midnight deadline for euro-area governments to turn in fiscal budgets.

Meanwhile, Crude and Brent are up 0.6% and 0.9% respectively amidst supply concerns following possible U.S sanctions against Saudi Arabia over missing journalist Khashoggi, which Saudi say they will respond in kind to if implemented. Prices are currently just over USD 71.5/bbl and USD 81/bbl respectively. Additionally, IEA’s Birol stated that high oil prices are hurting consumers and that extra barrels will need to come to the market soon to avoid further tightening.

Gold is once again up with mass uncertainty in the market from unproductive Brexit talks, US-China trade war and Italian’s budget deadline day causing investors to move into the safe haven. Global trade tensions have also caused selling pressure in London metals causing prices to slip. Shanghai rebar steel futures climbed to their highest levels in over 3 weeks, boosted by  expectations that China’s sustained anti-pollution campaign could further disrupt production.

Expected data include retail sales and Empire State manufacturing. Bank of America, Schwab, and JB Hunt are among companies reporting earnings

Market Snapshot

• S&P 500 futures down 0.7% to 2,749.00
• STOXX Europe 600 down 0.6% to 356.81
• MXAP down 1.1% to 152.56
• MXAPJ down 1% to 479.89
• Nikkei down 1.9% to 22,271.30
• Topix down 1.6% to 1,675.44
• Hang Seng Index down 1.4% to 25,445.06
• Shanghai Composite down 1.5% to 2,568.10
• Sensex up 0.1% to 34,775.90
• Australia S&P/ASX 200 down 1% to 5,837.10
• Kospi down 0.8% to 2,145.12
• German 10Y yield fell 0.8 bps to 0.49%
• Euro up 0.01% to $1.1561
• Italian 10Y yield rose 1.3 bps to 3.203%
• Spanish 10Y yield fell 0.4 bps to 1.672%
• Brent futures up 0.7% to $80.98/bbl
• Gold spot up 1% to $1,229.01
• U.S. Dollar Index down 0.1% to 95.11

Top Headlines

• The U.K. and the European Union are on course to miss this week’s key milestone on the road to a Brexit deal after talks broke up in stalemate on Sunday. Talks are now paused after weekend negotiations failed to break deadlock; EU now considering a crisis summit in November for no-deal contingency planning according to people familiar
• Sears Holdings Corp., the 125-year-old retailer that became an icon for generations of American shoppers, filed for bankruptcy, saddled with billions of dollars of debt racked up as it struggled to adjust to the rapid shift toward online consumption
• After weeks of conflicting messages from Rome, market turmoil, and an early warning that the spending plans would breach EU rules, the European Commission will start reviewing Italy’s plan to start delivering on costly election promises
• Chancellor Angela Merkel faces a new round of coalition turbulence after her Bavarian sister party dropped to a historic low in a regional election that exposed the scope of voter disaffection with Germany’s political establishment
• Mnuchin: wants a currency clause that would prevent competitive devaluations to be included in any trade talks with Japan; Kudlow says Trump is concerned that the Fed might choke off the U.S. recovery
• ECB’s Rehn: latest core inflation numbers were somewhat disappointing; ECB should gradually move to data- dependent rate guidance
• PBOC Governor Yi: sees no reason to hike rates; China won’t use its currency as a tool to deal with trade conflicts
• Saudi Arabia: Trump says Saudi would face “severe punishment” if linked to disappearance of Khashoggi; State news says kingdom will retaliate against any measures with even stronger response.

Asian equity markets resumed last week’s stock rout as the region failed to take impetus from Friday’s rebound on Wall Street where tech outperformed and all majors finished a tumultuous session in the green, albeit with losses of around 4% on the week. ASX 200 (-1.0%) slumped from the open as financials and tech led the broad losses which dragged the index briefly below the 5800 level, while Nikkei 225 (-1.9%) suffered from continued flows into the JPY. Elsewhere, Shanghai Comp. (-1.5%) and Hang Seng (-1.4%) conformed to the negative tone with sentiment not helped by President Trump’s reiteration that the US may have to impose another round of tariffs on China, with indecision seen in the mainland after the PBoC skipped open market operations and refrained from rolling over maturing MLF loans as its previously announced 100bps RRR cut took effect. Finally, 10yr JGBs were pressured at the open and tracked the recent weakness in T-notes, but then recovered as the widespread risk averse tone spurred safe-haven demand.

Top Asian News

• SoftBank Dive Hits $22 Billion Amid Saudi Outcry, Tech Rout
• China’s Stocks Extend $3 Trillion Rout as Consumer Firms Crumble
• Asian Stock Markets Fall. And There’s a Slew of Reasons Why
• Singapore Home Sales Rebound as Buyers Move Past Curbs

Main European Indices are mixed amid current market uncertainty; the Dax is up (+0.3%) despite being weighed on by Lufthansa
which is down by over 3% following agreements on new employment conditions, featuring moderate salary increases. Sectors are mixed with IT lagging at -1% as a follow on from poor IT performance in Asia due to continued U.S-China tension; this is despite Friday’s Wall Street rebound for IT which saw it as the leading sector finishing up by 3%. Convatec are down by over 25% following a cut in their revenue guidance. Chr Hansen are up by over 2% following a positive earnings update and reports that their chairman will not seek re-election, with Dominique Reiniche to be nominated as the next chairman.

Top European News

• Speed Trader Hudson River Chooses Dublin as Post-Brexit Home
• Greencore to Sell Troubled U.S. Food Unit for $1.1 Billion
• Frankfurt Trading Resumes After Open Delayed by Technical Glitch
• S&P Upgrade Boosts Zloty and Bonds as EM Woes Threaten Rally

In FX, JPY – The clear G10 outperformer and beneficiary of a downturn in Asia-Pacific stocks as jitters over global trade, protectionism and sanctions undermined sentiment. Usd/Jpy has retreated from 112.25 highs and through 112.00 to a 111.70 low, breaching the 55 DMA at 111.83, while Eur/Jpy is back below 129.50 alongside broadly softer Jpy crosses. From a technical perspective, 111.50 will be eyed next on the downside as a psychological marker and 50% Fib, roughly aligning with daily support around 111.47 plus decent option expiry interest between 111.55-40 (1 bn). GBP – At the opposite end of the spectrum, the Pound has been undermined by a breakdown in talks between the UK and EU just days ahead of the latest scheduled Brexit summit that may now take the form of a no deal meeting given the ongoing Irish border impasse. Cable has managed to regain some composure and recoup losses under 1.3100, but Eur/Gbp is holding above 0.8800 where a hefty expiry lies (1 bn). In EM – The Try remains bid just off 5.8160 peaks vs the Usd on follow-through buying/relief in wake of the release of US Pasto Brunson, while the Rub and Zar are also up vs the Buck (circa 65.6500 and 14.4500) on firm Brent and Gold.

In commodities, Crude and Brent are up 0.6% and 0.9% respectively amidst supply concerns following possible U.S sanctions against Saudi Arabia over missing journalist Khashoggi, which Saudi say they will respond in kind to if implemented. Prices are currently just over USD 71.5/bbl and USD 81/bbl respectively. Additionally, IEA’s Birol stated that high oil prices are hurting consumers and that extra barrels will need to come to the market soon to avoid further tightening. Gold is once again up with mass uncertainty in the market from unproductive Brexit talks, US-China trade war and Italian’s budget deadline day causing investors to move into the safe haven. Global trade tensions have also caused selling pressure in London metals causing prices to slip. Shanghai rebar steel futures climbed to their highest levels in over 3 weeks, boosted by expectations that China’s sustained anti-pollution campaign could further disrupt production.

It’s a quiet start to the week. In the European morning, the only release of note in Europe is Italy’s August general government debt numbers. In the US, we’ll see the October Empire manufacturing release along with September retail sales and August business inventories. Away from the data, ECB vice president Luis de Guindos will speak at an event in Madrid while, Euro-area countries including Italy send final budgets to the EC for approval. Bank of America will report earnings.

US Event Calendar

• Oct. 15-Oct. 18: Monthly Budget Statement, est. $75.0b, prior $7.9b
• 8:30am: Empire Manufacturing, est. 20, prior 19
• 8:30am: Retail Sales Advance MoM, est. 0.6%, prior 0.1%
• 8:30am: Retail Sales Ex Auto MoM, est. 0.4%, prior 0.3%
• 8:30am: Retail Sales Ex Auto and Gas, est. 0.4%, prior 0.2%
• 8:30am: Retail Sales Control Group, est. 0.4%, prior 0.1%
• 10am: Business Inventories, est. 0.5%, prior 0.6%

 

DB’s Jim Reid concludes the overnight wrap

Most of the blame for last week’s market turbulence was the move in yields from the previous week. The support actors have been Italy, the ongoing trade dispute and perhaps a little bit of Brexit uncertainly (of which the news flow hasn’t got much better over the weekend. US bond markets should take most of the responsibility though even if they did rally back a little in the latter part of the week. Given this, its worth highlighting that over the weekend here at DB we have reiterated our 2018 YE 10-year Treasury forecast at 3.50% but edged up the forecast to 3.70% for Q1 2019 and at 3.80% by the end of Q3 2019. By YE 2019 the forecast is back to 3.60% due to the possibility of the house view of potential US rate cuts in H2 2020 being priced in after five more hikes before the end of next year. In addition, 10-year Bunds are expected to be 1.25% by the end of 2019. See the report here for more details.

The key events for this week are the Italian budget being submitted to the EC today, China’s inflation data tomorrow, the latest FOMC minutes on Wednesday, the EU leaders Summit to discuss Brexit on Wednesday and Thursday, China’s monthly data dump on Friday and US earnings season kicking slowly into gear. Brexit headlines here in the UK will likely to be intense all week with negativity being the overriding theme last night as Brexit Secretary Raab travelled to Brussels yesterday to communicate to Michel Barnier that Mrs May couldn’t sign up to what is currently being offered and discussed. Elsewhere, EU’s chief Brexit negotiator Michel Barnier tweeted yesterday that “despite intense efforts, some key issues are still open, including the backstop for IE/NI to avoid a hard border.” The pound has fallen -0.35% in Asian trading as a result. This news followed intense weekend negotiations with many hoping today would see the outline of a deal announced. This seems highly unlikely now and some attention will turn to whether this week’s EU leaders summit will conclude that the November summit should be about preparing for a no-deal Brexit instead of ratifying a successful one. Tomorrow the UK has a cabinet meeting devoted to Brexit so plenty to watch out for. At this point in time I’ve absolutely no idea how this is all going to work out. There are so many immovable obstructions on all sides. However, with all things EU related over the years one learns that until 23.59:59 ticks over to midnight then there’s always a chance of a deal.

Staying with weekend politics, the Bavarian election saw the CSU – German Chancellor Angela Merkel’s coalition partners – see their vote share decline to 37.2% down from 47.7%, marking the worst performance for the CSU since 1950 while the center-left Social Democrats share declined to 9.7% down from 20.6%, marking the worst performance since World War 2. The Greens and AfD’s vote share rose to 17.5% and 10.2%, respectively. Our economists have previously stated that a poor showing for the CSU might trigger a reshuffle of Merkel’s cabinet, i.e., the ousting of Seehofer as Minister of the Interior, fostering better co-operation among the Groko, enhancing the federal government’s efficiency, and shifting the government’s stances, especially on asylum policy and European policy. The exact impact will depend on the CSU’s future coalition partner in Bavaria. Their baseline scenario is for a coalition among the CSU, the Free Voters, and the FDP.

The week has started off with a risk-off tone in Asia, despite last Friday’s rebound in global equities. The Nikkei (-1.30%), Hang Seng (-1.01%), Shanghai Comp (-0.79%) and Kospi (-0.52%) all lower. Elsewhere, futures on S&P 500 (-0.18%) are pointing to a slightly weaker start. Overnight, BoJ Governor Kuroda said that “the amount of JGB purchases is no more the monetary operating target” adding, “It’s only yield curve control.” This further reinforces that the BoJ’s commitment to buy JPY 80tn of JGBs each year is only symbolic now.

Last week was a tough one for risk assets, with most major equity indexes posting their worst week since the February-March sell-off even if Friday ended on a high as we’ll show below. The S&P 500, DOW, and NASDAQ closed -4.10%, -4.19%, and -3.27% lower on the week. Cyclical sectors – industrials, materials, financials, and energy – were the worst-performing sectors, while the safe havens of utilities and consumer staples were the best performers. Small-caps continued their recent trend by lagging behind the broader market, with the Russell 2000 down -5.23%, their worst week since January 2016 and their 7th consecutive week of underperformance versus the S&P 500 – the longest such streak in over a year. The VIX index rose to as high as 28.8 and closed at 21.3, its highest level since April and biggest move since March.

The Euro Stoxx 600 shed -4.64%, roughly in line with the DAX (-4.86%) and CAC (-4.91%), while the FTSEMIB lagged behind (-5.36%). In Asia, the Nikkei and KOSPI shed -4.58% and -4.95%. Chinese bourses were hit hard after being closed for the first week of October, with the CSI 300, Shanghai Composite, and Shenzhen Composite losing -7.60%, -7.80%, and -10.07%, respectively. Broader emerging markets actually held up well over the course of the week, with the MSCI EM index down only -1.35% and EM currencies gaining +0.76%. They were boosted by a soft US CPI print on Wednesday and a generally softer dollar (-0.38%).

On Friday markets found their footing and pared their losses, with the S&P 500, DOW, and NASDAQ gaining +1.42%, +1.15%, and +2.77%, respectively, on the day. Treasury yields resumed their rise, rising +1.5bps on Friday but were still -6.8bps lower on the week. Given the equity sell-off this was a relatively mild rally showing that there does seem to be a structural element to the recent rise in yields. Elsewhere, Bunds outperformed and yields dipped another 2.0bps to take their weekly rally to 7.5bps, while peripheral spreads were mostly wider.

Noise continued to emanate from Italy regarding the budget, but we didn’t get any substantive new information and the sell-off in BTPs (+15.3bps) wasn’t notably more painful than in Spain (+9.7bps) or Portugal (+9.9bps). After the close on Friday, Moody’s upgraded Portugal’s debt to investment grade, though it feels more like the agency catching up to the market than the other way around.

US banks effectively kicked off the third quarter earnings season on Friday, though the results were understandably  overshadowed by the broader market moves. Still, they were mostly positive. Citi posted lower expense than expected while maintaining revenue in line, JP Morgan saw revenues grow a healthy 7% yoy, and Wells Fargo exceeded DB’s expectations on costs despite a headline earnings miss. Bank stocks nevertheless led losses on Friday, with the S&P 500 bank index shedding -0.40% despite the broader rally to end the week -5.43% lower.

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