Tag: news

By Michael Wilson, Morgan Stanley’s chief US equity strategist

Our US equity strategy process has several key components. Most importantly, we focus on the fundamentals of growth and valuation to determine whether the overall market is attractive and which sectors and styles look the best. The rate of change in growth is more important than the absolute level, and we use a market-based equity risk premium framework that works well as long as you apply the right regime when using it. In that regard, we’re avid students of market cycles and believe that historical analogies can be helpful. For example, the mid-cycle transition narrative that has worked so well since March came directly from our study of historical economic and market cycles.

The final component we spend a lot of time studying is price, i.e., technical analysis. Markets aren’t always efficient, but we believe that they are often very good leading indicators for fundamentals – the ultimate driver of value. This is especially true if one focuses on sector and style leadership and relative strength of individual securities. In short, we find these internals to be much more useful than simply looking at the major averages.

This year, we think that the process has lived up to its promise as the price action has lined up nicely with the fundamental backdrop. More specifically, cyclicals dominated growth stocks in the first quarter during the most accelerative phase of the early-cycle recovery. Large-cap quality leadership since March is signalling what we believe is about to happen – decelerating growth and tightening financial conditions. The question for many investors now is whether the price action has already discounted these fundamental outcomes. The short answer, in our view, is no.

Equity markets sold off sharply two Mondays ago on concerns about an Evergrande bankruptcy. While our house view is that it won’t lead to major financial spillover, it will weigh on China’s growth. This means that the growth deceleration we (and the markets) were already expecting will likely be worse and is probably not fully priced in. The other reason why equity markets were soft a few weeks ago had to do with concerns about the Fed articulating its plans to taper asset purchases. The Fed did not disappoint, as it essentially told us to expect the taper to begin this year. The surprise was the speed with which it expects to be done tapering – by mid-2022. This is about a quarter sooner than the market had been anticipating and increases the probability of a rate hike in 2H22, a clearly hawkish shift.

After the Fed meeting on Wednesday, real 10-year yields were up 12bp in two days and are now up 31bp in just eight weeks. In addition, the US dollar was stronger. Both weighed heavily on equity markets. In other words, tapering is tightening for stocks even if it isn’t for the economy – the more important consideration for the Fed. In short, higher real rates should mean lower equity prices. Secondarily, they may also mean value over growth even as the overall equity market goes lower. This makes for a doubly difficult investment environment given how most investors are positioned. Finally, the most powerful offset to a material correction in the S&P 500 this year has been the extremely resilient buy-the-dip mentality among retail investors, a strategy that is now being challenged. After the Evergrande dip and rally, stocks have probed lower and taken out the prior lows, making this the first time that buying the dip hasn’t worked, simultaneously violating important technical support.

For the past month, our strategy has been to favor a barbell of defensive quality sectors like healthcare and staples, together with financials. The defensive stocks should hold up better as earnings revisions start to come under pressure from decelerating growth and higher costs, while financials can benefit from the higher interest rate environment. On the other side of the ledger are consumer discretionary stocks, which remain especially vulnerable to a payback in demand from last year’s over-consumption. Within that bucket we favor services over goods, where we think there remains some pent-up demand. The risk to earnings may also be higher than average for some tech stocks levered to the work-from-home dynamic that is now fading. Within the sector, we are most concerned about semiconductors and neutral overall.

The International Alliance of Theatrical Stage Employees, one of Hollywood’s most prominent unions, is eyeing a strike.

In what could be a massive blow to movie and TV studios, many of whom are still trying to deal with fallout from the pandemic, the union’s leaders have hit an impasse while seeking shorter working hours as part of a new contract, Bloomberg reported Thursday.

The request has been in response to longer hours that have become the norm since Covid shut down a large portion of the industry.

The union has a membership of about 60,000, most of whom are based in Los Angeles. They are threatening to walk off the job, should the union’s leadership – which is countrywide – decide. This means that a strike would affect studios across the U.S., not just in Los Angeles. 

In total, 1 million jobs “directly tied to film and TV production” could be affected.

Alongside of a historic labor shortage coming back from the pandemic, production has been on the rise as the studio arms of companies like Netflix and Amazon look to build out their content. Both Netflix and Walt Disney have told shareholders that the lack of new content has been a headwind for streaming sign-ups. 

The Alliance of Motion Picture and Television Producers says it “put forth a deal-closing, comprehensive proposal that meaningfully addresses the IATSE’s key bargaining issues.” 

But the union isn’t amused. It wrote to its members: “As you may be aware, negotiations with the major producers have reached a standstill. They refused to reply to our last proposal.”

The union is pushing for rest and meal breaks, as well as higher pay for its lowest earners, some of whom only make $15 per hour. 

The IATSE has never gone on strike in its history, though both parties likely remember a writers strike from 13 years ago that lasted 100 days. 

An IATSE strike could “cripple” the production industry, Bloomberg wrote. 

Authored by James Rickards via DailyReckoning.com,

The happy talk out of Wall Street would have you believe that the Evergrande financial collapse in China is under control and that responsible parties have taken steps to avoid a “Lehman moment” in Chinese capital markets.

Almost everything about that narrative is factually wrong. It’s Wall Street happy talk at its finest, assuring investors that things are under control while the smart money runs for the hills. Something closer to the truth was reported the same day in The Wall Street Journal. Here’s their summary:

Chinese authorities are asking local governments to prepare for the potential downfall of China Evergrande Group, according to officials familiar with the discussions, signaling a reluctance to bail out the debt-saddled property developer while bracing for any economic and social fallout from the company’s travails…

Local governments have been ordered to assemble groups of accountants and legal experts to examine the finances around Evergrande’s operations in their respective regions, talk to local state-owned and private property developers to prepare to take over local real estate projects and set up law enforcement teams to monitor public anger… a euphemism for protests, according to the people.

China’s Bogus Plan

This actual crisis management plan is the worst possible playbook. Why?

Any response to a financial crisis has to be centralized so that decisions about how to deploy limited resources can be made rapidly. Some lenders must be saved, some should be allowed to fail. Equity holders should be wiped out. Foreign investors in dollar-denominated debt of Evergrande will be left to fend for themselves and possibly seek relief in their home countries.

The point is these types of decisions cannot be made by “local governments” as proposed by the Chinese. The government plan is not a serious effort to truncate a financial crisis. It seems designed more to suppress social unrest and perhaps arrest “troublemakers.”

Western analysts don’t understand this dynamic because they view events through the lens of Wall Street and Washington norms.

But the Communist Party of China does not care if Chinese oligarchs or investors in BlackRock ETFs lose money. That suits them fine. They’re communists.

The Good News and the Bad News

The good news is that the China myth has now been revealed to be a fraud. The globalist dream for China has crashed and burned. Good riddance.

Chinese regulators believe they have the resources to bail out or restructure Evergrande with some haircuts for creditors.

They probably do, but that misses the point.

Evergrande investors are now staging protests at banks after learning that their loans to Evergrande will not pay out for two years. Of course, Evergrande will be bankrupt long before that, and the investors will get nothing in the end.

This is another fiasco in the making because those investors will dump that unwanted real estate, which will collapse the property market in turn. Essentially, Chinese regulators are so desperate that they are trying to pay off creditors in kind with deeds to real estate that no one wants.

The Chinese are only looking at what’s inside the four walls of Evergrande and ignoring the fact that their entire property and financial system is on the verge of a world-historic crack-up.

But here’s the real problem: The damage will not be confined to Evergrande. It will spread quickly to counterparties of Evergrande, including other developers and banks.

This unprecedented combination of a financial crisis and Communist indifference could result in full-blown contagion that could emerge as a crisis in the U.S. and Europe within a few months.

I’ve predicted this all along, but in reality, it wasn’t that hard to predict. The Chinese economy is basically a debt-driven Ponzi scheme.

Up to half of China’s investment is a complete waste. It does produce jobs and utilize inputs like cement, steel, copper and glass. But the finished product, whether a city, train station or sports arena, is often a white elephant that will remain unused. The Chinese landscape is littered with “ghost cities” that have resulted from China’s wasted investment and flawed development model.

And as I’ve explained before, that has serious implications for China’s leadership…

The “Mandate of Heaven” in Jeopardy

China’s economy is not just about providing jobs, goods and services. It is about regime survival for a Chinese Communist Party that faces an existential crisis if it fails to deliver.

It is an illegitimate regime that will remain in power only so long as it provides jobs and a rising living standard for the Chinese people. The overriding imperative of the Chinese leadership is to avoid societal unrest.

If China’s job machine seizes, as parts of it did during the coronavirus outbreak, Beijing fears that popular unrest could emerge on a scale potentially much greater than the 1989 Tiananmen Square protests. This is an existential threat to Communist power.

President Xi Jinping could quickly lose what the Chinese call “the Mandate of Heaven.”

That’s a term that describes the intangible goodwill and popular support needed by emperors to rule China for the past 3,000 years. If the Mandate of Heaven is lost, a ruler can fall quickly.

Even before the present crisis, China has had serious structural economic problems that are finally catching up with it.

China is so heavily indebted that it is now at the point where more debt does not produce growth. Adding additional debt today slows the economy and calls into question China’s ability to service its existing debt.

Essentially, China is on the horns of a dilemma with no good way out. China has driven growth for the past eight years with excessive credit, wasted infrastructure investment and Ponzi schemes.

The Chinese leadership knows this, but they had to keep the growth machine in high gear to create jobs for millions of migrants coming from the countryside to the city and to maintain jobs for the millions more already in the cities.

Will China Try to Create a Dangerous Diversion?

The two ways to get rid of debt are deflation (which results in write-offs, bankruptcies and unemployment) and inflation (which results in theft of purchasing power, similar to a tax increase).

Both alternatives are unacceptable to the Communists because they lack the political legitimacy to endure either unemployment or inflation. Either policy would cause social unrest and unleash revolutionary potential.

The question is will China move aggressively against Taiwan, for example, to distract the people and attempt to unite them?

China does not want war at this time. But diverting the people’s attention away from domestic problems toward a foreign foe is an old trick leaders use to unite the people in times of uncertainty.

If China’s leadership decides that the risk of losing legitimacy at home outweighs the risk of conflict that would likely involve the United States, the likelihood of war rises dramatically.

I’m not making a specific prediction, but wars have started over less. This is a very dangerous time.

The National Restaurant Association (NRA) penned a letter to Speaker Pelosi, Leaders Chuck Schumer, Kevin McCarthy, and Mitch McConnell about the restaurant industry’s dire situation heading into the fall season. 

NRA said the “struggling restaurant industry is of grave concern to us.” The association included a new survey of the industry’s economic conditions and concluded the “state a recovery from the pandemic will be prolonged well into 2022.” They warned: “the majority of full-service and limited-service operators say business conditions are worse now than three months ago.” 

The findings below are on the heels of soaring food inflation, labor shortages, and logistical nightmares that have made some restaurant items nearly impossible to obtain. 

• 78% of operators say their restaurant experienced a decline in customer demand for indoor, on-premises dining in recent weeks because of the delta variant spike. 

• 63% of operators said their sales volume in August, historically one of the busiest months for restaurants, was lower than it was in August 2019. 

• Costs are up – 91% of operators are paying more for food; 84% have higher labor costs; 63% are paying higher occupancy costs, but profitability is down – 85% of operators reported smaller margins than before the pandemic.

• Although the industry has added back many of the jobs lost during the pandemic, 78% of operators say their restaurant doesn’t have enough employees to support current customer demand.

• 95% of restaurant operators say their restaurant experienced supply delays or shortages of key food or beverage items during the past three months.

The new findings paint a grim economic backdrop for President Biden’s “Build Back Better” plan and suggest the stagflation is begging to bite. After all, more and more economists are warning about the increasing risk of 1970s-style stagflation, the latest to warn was Stephen Roach. 

A separate study by small business networking site Alignable, conducted between Aug. 28 and Sept. 27, found that most restaurants (51%) were unable to cover their September rent. 

Both studies suggest the return to normalcy for restaurants is puttering out as deterioration in finances due to surging costs, labor shortages, and a decline in traffic may indicate another round of restaurant busts are ahead. 

By Tony Pasqsuariello, Goldman Sachs’ head of Hedge Fund Sales in US Equity Derivatives,

The key story over recent weeks has been a nascent return of the reflation theme. To be sure, price action across the macro complex hasn’t been subtle — be it higher rates, another charge higher in commodities or the searing outperformance of cyclicals over growth stocks — yet, this is a different scene from the high velocity days of November through March.

Whereas the franchise dialogue then was characterized by hopes for unbounded fiscal spending, a sincere Fed commitment to the AIT framework and blockbuster payrolls prints … the recent story line has centered more on the FOMC taking their first clear step towards normalizing policy, energy markets contending with some very serious supply-and-demand issues and positioning/mis-positioning.

That said, where you can find common ground between the two episodes is around the biggest fundamental variable in the markets: the interplay between COVID and global economic activity.

Amidst all the noise and cross-currents and debate around first derivatives vs second derivatives, the fact is this: the global economy is firing on more cylinders today than at any point in the COVID era.

For example, witness the GS Effective Lockdown Index, which trends in the right direction and clearly identifies a recent inflection from the Delta impingement — taking the index to its easiest level since the early days of the pandemic.

Here’s another framing from long-time colleague Dominic Wilson: “for me the big difference is that last year it was about large, new positives — now it’s about removal of some downside stuff against a slowing trend so it’s all a bit more tactical. and, the upside tails aren’t really being restored.”

Looking ahead, here’s where I come out, taker of feedback:

1. Point-to-point, there’s been no better horse in the reflation race than commodities — and, if the first point in the section below is correct, for medium-term investors, that could well remain the case.
2. It’s not totally obvious to this stock operator where the bond market goes from here. given the inflation debate, I do think the asymmetry is skewed towards higher rates than lower rates. the house view continues to be 1.60% on 10-year notes at year end, with an ultimate path to 2.50% (link).
3. Given that point on rates, it’s also not clear to me that you’re supposed to be sliding all of your chips from secular winners to cyclicals; I’d prefer to keep an ongoing balance there, while overtly avoiding the bond proxies. said another way: cyclicals-over-defensives is a clearer axis to me than value-over-growth.
4. On S&P more broadly, as we approach a very strong seasonal period, I continue to believe the path of least resistance is higher. at the same time, I also suspect we’ll be living with a higher base level of volatility for a while — with that comes a choppier trading environment where the bulls get paid by adding exposure on dips.
5. If global central banks are getting out of the bond buying business, one can expect it will happen at different speeds and with different exit strategies. as a crafty client suggested, from a very boring starting point, this should open the door to a better opportunity set in FX trading. note, quietly, DXY has made YTD highs.

Several other quick points, charts:

1. Commodities: another week, another higher high in BCOM, with an eye-popping sequence in the European power markets. In the GIR upgrade to our oil forecast, I found it a little interesting they touched up YE’21 Brent from 80 to 90 … I found it more interesting that the 2023 bogey moved from 65 to 85 (link).

2. The Fed: from an arguably absurd starting point, last week marked the first step towards a glide path — if a very long path — to something resembling policy normalization. I looked back at the ’04-’06 analog: the Fed hiked rates 17 times, they were most perfectly predictable in doing so, and market volatility collapsed along the way. while I imagine they’d be happy with a similar outcome, again my instinct is that analog may not apply all over again.

3. Japan: it’s a big week for the ever pivotal Japanese election cycle, with an outcome that skews as generically market friendly. coupled with a much better outlook for COVID and the reset in global interest rate curves, the bullish house call for Japanese equities still aligns with my instincts: link.

4. China: GIR published an eye opening note on their property market (link). at 20% of GDP and 62% of household wealth, thus totaling $60tr, one can argue it’s the largest asset class in the world (btw, am I the only person who didn’t realize that).

5. From the 2017 market journal, when S&P never traded negative at any point in the year en route to a 22% total return and a 3 Sharpe:

• i. “maybe someday we’ll look back and be astounded that central banks bought $14tr bonds. or, maybe, they will still be buying.” note that since last March, the big four central banks have bought another ~ $5.5tr.
• ii. with updates: “in the 20th century, the Dow went from 66 to 11,497 (a gain of 17,320%). in the 21st century, the index is up a further 402%.”
• iii. with updates: “total returns since the ’04 IPO: Alphabet/Google + 6,312% … Domino’s Pizza + 7,148%.”
• iv. “remember, 10% of cumulative alpha per year breaks down to … 4 bps per trading day.”
• v. while not for deployment in this email, “data shows there’s a positive correlation between swearing and perceptions of honesty.”

6. When the market is trading at multiples not seen outside of the tech bubble, it’s fair to wonder if one of the big challenges is priced-to-perfection risk? I asked Ben Snider in GIR to zoom in a bit on valuation in the context of the COVID era. the sequence has been interesting: since the market bottomed last March, only 32% of the rally has been driven by earnings … the balance of 68% was re-rating of the multiple. that said, since the vaccine announcements last November, the entirety of the rally has been driven by earnings:

7. This is one of those big picture charts that doesn’t inform your risk taking in the short-term, but perhaps says a lot about the world in a broader sense. With credit to Peter Oppenheimer and team in GIR, this contextualizes just how big US mega cap tech companies are relative to the GDP of various large countries and indices:

8. Following on from there … again with credit to Ben Snider … this a very simple snapshot of annual total returns in the FAAMG complex post-GFC … for all of the local turbulence of recent weeks, I still think there’s a lot to like here long-term:

9. To level set positioning in the hedge fund community, this lays out the recent history in both gross exposure (left side) and net exposure (right side). While I am very aware that US households have gone whole-hog into stock market, the professional trading community is, by contrast, relatively sober in current risk taking. As someone put it to me: there’s lots of optimism, but lots of cash … That’s not how bull markets usually end.

CDC Director Rochelle Walensky said last week that Covid vaccines ‘can’t prevent transmission‘ anymore despite working “exceptionally well.”

“Our vaccines are working exceptionally well. They continue to work well for Delta with regard to severe illness and death – they prevent it, but what they can’t do anymore is prevent transmission,” she told CNN‘s Wolf Blitzer. “So if you’re going home to someone who is not vaccinated…I would suggest you wear a mask in public indoor settings,” she continued.

CDC director Rochelle Walensky says that the vaccine *cannot* prevent transmission. So why are all these Pro-Vaxxers saying that it can? pic.twitter.com/8aaDTh8N3T

— Anthony Brian Logan (ABL) 🇺🇸 (@ANTHONYBLOGAN) October 2, 2021

That said, Walensky may have actually undersold the vaccines. According to a preprint study by British scientists at the University of Oxford, people who have taken AstraAeneca’s Covid-19 vaccine and contract the virus are just as likely to spread it as the unvaccinated after 90 days, while the Pfizer vaccine’s ability to reduce transmission is “substantially” reduced over the same period, according to the records of nearly 150,000 contacts that were traced from approximately 100,000 initial cases.

As NBC News reports, “The samples included people who were fully or partially vaccinated with either the Pfizer-BioNTech (BNT162b2) or the AstraZeneca (ChAd0x1) vaccines, as well as people who were unvaccinated. The researchers then looked at how the vaccines affected the spread of the virus if a person had a breakthrough infection with either the alpha variant or the highly contagious delta variant.” Of note, both vaccines were more effective against the Alpha variant.

Initially, both vaccines reduced transmission from a fully vaccinated person to a given contact. Specifically, if a vaccinated individual is infected with the Delta variant, a given contact was 65% less likely to test positive if the infected had two doses of the Pfizer vaccine, and 36% less likely with AstraZeneca.

Yet, buried in the 14th paragraph of the report, NBC News notes:

The new study showed that protection against transmission seemed to wane over time, however. After three months, people who had breakthrough infections after being vaccinated with AstraZeneca were just as likely to spread the delta variant as the unvaccinated. While protection against transmission decreased in people who had received the Pfizer vaccine, there was still a benefit when compared with people who were unvaccinated.

In the words of the researchers, the Pfizer vaccine’s ability to reduce transmission was ‘substantially’ lower by week 12.

They also found that while the Pfizer vaccine was superior in reducing transmission to contacts, protection against Covid-19 in the first place waned faster vs. AstraZeneca.

As for where people are coming into contact with the infected – the study found that 70% occurred within households, 10% from household visitors, 10% at ‘events and activities,’ and 10% at work or school.

What does this mean for the holidays? According to Dr. Anthony Fauci, it’s ‘too soon to tell’ whether people can safely gather together for Christmas this year.

HOLIDAY LOOKAHEAD: “It’s just too soon to tell,” Dr. Anthony Fauci tells @margbrennan when pressed whether or not people can safely gather together for Christmas this year.

He says the country should instead concentrate on getting COVID cases down. pic.twitter.com/ey0ft9aCOh

— Face The Nation (@FaceTheNation) October 3, 2021

But you can “safely gather” 1000s for the Met gala or 900 at Obama’s birthday party? Fuck this guy. https://t.co/cRdLGaupap

— Stalingrad & Poorski (@Stalingrad_Poor) October 3, 2021

And why aren’t US officials acknowledging naturally acquired immunity?

The big issue with natural immunity is that nobody gets rich.

— Robert J. O’Neill (@mchooyah) October 2, 2021

With all the mixed messaging, is anyone really shocked at the widespread ‘vaccine hesitancy’ among healthcare professionals?

As the Babylon Bee jokes: