Month: December 2019

Submitted by Joseph Carson, Former Director of Global Economic Research, Alliance Bernstein

Stock market booms are often based on a “good” story or a narrative of better things to come. Excess liquidity usually provides the fuel for bull market runs, as fundamentals of growth and profits usually don’t play a major role, at least not initially.

In the past 5 years, the S&P 500 stock index has risen over 50% and during that period operating profits for non-financial companies have declined over 15%, a drop that has always been associated with economic recessions.

Source: Bloomberg

The big test for policymakers is how to assess when “irrational exuberance” over easy money has gone too far, creating a vision of little risks and a persistent bull market in stocks that unduly separates finance from the economy increasing the risk of a bad outcome?

The Great Divergence

The Bureau of Economic Analysis reported that Q3 operating profits for all US companies, large and small, public and private, totaled $2.087 trillion, off 0.8% from year ago levels. The decline in profits in the past year continues a long stretch of weak corporate earnings. In fact, operating profits peaked in Q3 2014 and over the past 5 years are off nearly 5%.

The weakness in operating profits is centered in non-financial companies—with the biggest declines in the manufacturing sector. In the past year, profits for non-financial corporate businesses declined nearly 5%, bringing the cumulative 5-year fall to 15.5%–three times larger than the decline for all companies.

Profit declines of this scale, and even less, have always been associated with an economic recession. In fact, since 1975, there have been 6 recessions and of those only two— the dot.com bust and the Great Financial Recession – recorded larger declines in operating profits than the current slump.

Yet, despite the decline in operating profits the broad equity markets has posted very strong gains, with the S&P 500 index up over 50% in the past 5 years, and the NASDAQ up over 80% – with both indexes posting gains of 25% to 30% in 2019 alone.

Divergence between profits and equity markets are not uncommon, but the scale and length of the current divergence is.
The primary fuel for the stock market run has been easy money and the promise of more easy money. Even though the economy’s performance in 2019 in terms of growth, jobless rate and core inflation was fairly close to the Fed’s forecast policymakers voted to reduce official rates three times instead of the initial plan to raise rates twice. That’s the equivalent of 125 basis points of an easier money stance relative what the financial markets had been expecting. Policymakers have also made a promise not to raise official rates until reported inflation is well above its preferred rate of 2%. 

In 1996, Federal Reserve Chairman Alan Greenspan raised the question “how do we know when irrational exuberance has unduly escalated asset values? Nowadays a similar question can be directed to the Fed – “How do we know when irrational exuberance over the Fed’s policy of easy money has unduly escalated asset values?”

History clearly shows excess liquidity fuels bull markets, but money has to at some point work its way into the real economy, lifting growth and profits. Bubbles form when excess liquidity remains bottled in one segment of finance or single sector of the economy – like during the dot.com and housing bubbles.

Monetary policy can create liquidity, but it can’t direct its flow – and the current flow remains unbalanced between finance and the real economy.

While Elon Musk spent his evening on Twitter (again) complaining about short sellers… 

Bravo, right thing to do! Short selling should be illegal.

— Elon Musk (@elonmusk) December 3, 2019

…we are reminded that it was his use of Twitter when talking about British cave diving hero Vern Unsworth that will be leading Musk into the courtroom this morning, as he heads to trial for allegedly defaming Unsworth when he referred to him as “pedo guy”.

Unsworth helped play a key role in saving 12 boys and their soccer coach who were trapped in the Tham Luang Nang Non cave in Thailand in July 2018.

Musk had proposed his own solution for the rescue, embarking on a boastful public quest to construct a device that could help rescue the trapped children. But, ultimately, the rescue was done by actual professionals and without the help of Musk.

In a post-rescue interview with CNN, Unsworth laughed off Musk’s proposed solution and told the billionaire he could “stick it where it hurts”, disregarding Musk’s effort as a “PR stunt”. 

Musk, like a child who had just been bested on an elementary school playground, fired back by calling Unsworth names and insisting that he was a pedophile both on Twitter, and in communications with a reporter at BuzzFeed.

Unsworth obviously contends that Musk’s statements are false and that he should pay punitive and other damages for harming his reputation. 

The trial will last about 5 days and Musk is scheduled to be one of the first, if not the first, witness to testify. 

Several weeks ago, the judge presiding over the cast tossed the idea of Musk having a free speech defense, ruling that the statements did not have any basis in any public controversy involving Unsworth. Unsworth’s lawyer, L. Lin Wood said after the hearing that “the burden of proof for negligence is lower than that for actual malice”. 

This means that Unsworth will only have to convince the jury by a preponderance of the evidence, rather than clear and convincing evidence, making it easier for the panel to find Musk liable for defamation, Wood said.

Punitive damages could come as a result of the jury finding that Musk acted with malice, according to Wood. 

Recall, back in October, we noted that Musk called himself a “fucking idiot” of his choice of words about Unsworth when he emailed a reporter unverified information about the cave diver. 

We also documented when Unsworth first filed suit in late 2018. 

Authored by Lance Roberts via RealInvestmentAdvice.com,

With the third quarter of 2019 reporting season mostly behind us, we can take a look at what happened with earnings to see what’s real, what’s not, and what it will mean for the markets going forward.

The Good

As always is the case, the majority of companies beat their quarterly estimates, as noted by Bespoke Investment Group.

With 73% of companies beating estimates, it certainly suggests that companies in the S&P 500 are firing on all cylinders, which should support higher asset prices.

However, as they say, the “Devil is in the details.” 

The Bad

As I noted previously:

One of the reasons given for the push to new highs was the ‘better than expected’ earnings reports coming in. As noted by FactSet: 

“73% have reported actual EPS above the mean EPS estimate…The percentage of companies reporting EPS above the mean EPS estimate is above the 1-year (76%) average and above the 5-year (72%) average.”

The problem is the ‘beat rate’ was simply due to the consistent ‘lowering of the bar’ as shown in the chart below:

Beginning in mid-October last year, estimates for both 2019 and 2020 crashed. 

This is why I call it ‘Millennial Soccer.’ 

Earnings season is now a ‘game’ where scores aren’t kept, the media cheers, and everyone gets a ‘participation trophy’ just for showing up.

Let’s take a look at what really happened with earnings.

During Q3-2019, quarterly operating earnings declined from $40.14 to $40.05 or -0.25%. While operating earnings are completely useless for analysis, as they exclude all the “bad stuff” and mostly fudge the rest, reported earnings declined by from $34.93 to $34.33 or -1.75%.

While those seem like very small declines in actual numbers, context becomes very important. In Q3-2018, quarterly operating earnings were $41.38 and reported earnings were $36.36. In other words, over the last year operating earnings have declined by -3.21% and reported earnings fell by -5.58%. At the same time the S&P 500 index has advanced by 7.08%.

It’s actually worse.

Despite the rise in the S&P 500 index, both Operating and Reported earnings have fallen despite the effect of substantially lower tax rates and massive corporate share repurchases, which reduce the denominator of the EPS calculation.

Steve Goldstein recently penned for MarketWatch

“Research published by the French bank Societe Generale shows that S&P 500 companies have bought back the equivalent of 22% of the index’s market capitalization since 2010, with more than 80% of the companies having a program in place.

The low cost of debt is one reason for the surge, with interest rates not that far above zero, and President Trump’s package of tax cuts in 2017 further triggered a big repatriation of cash held abroad. Since the passage of the Tax Cuts and Jobs Act, non-financial U.S. companies have reduced their foreign earnings held abroad by $601 billion.

This repatriation may have run its course, and stock buybacks should decline from here, but they will still be substantial.”

This is no small thing.

As noted in “4-Risks To The Bullish View,”  previously, share repurchases have made up roughly 100% of the net purchases of stocks over the last year.

We have discussed the issue of “share buybacks” numerous times and the distortion caused by the use of corporate cash to lower shares outstanding to increase earnings per share.

“The reason companies spend billions on buybacks is to increase bottom-line earnings per share, which provides the ‘illusion’ of increasing profitability to support higher share prices. Since revenue growth has remained extremely weak since the financial crisis, companies have become dependent on inflating earnings on a ‘per share’ basis by reducing the denominator. As the chart below shows, while earnings per share have risen by over 360% since the beginning of 2009; revenue growth has barely eclipsed 50%.”

Chart updated through Q3-2019

The problem with this, of course, is that stock buybacks create an illusion of profitability. However, for investors, the real issue is that almost 100% of the net purchases of equities has come from corporations.

The issue is two-fold:

1. That corporate spending binge is slowing down, as noted by Mr. Goldstein; and,

2. If a recession sets in, share repurchases could easily cease altogether. 

If you don’t think that’s important, the charts above and below should at least make you reconsider.

Of course, such should not be a surprise.

Since the recessionary lows, much of the rise in “profitability” have come from a variety of cost-cutting measures and accounting gimmicks rather than actual increases in top-line revenue. While tax cuts certainly provided the capital for a surge in buybacks, revenue growth, which is directly connected to a consumption-based economy, has remained muted.

Since 2009, the operating earnings per share of corporations has risen 296%. However, the increase in earnings did not come from a commensurate increase in actual revenue which has only grown by a marginal 62% during the same period. At the same time, investors have bid up the market more than 300% from the financial crisis lows of 666.

Needless to say, investors are once again extremely optimistic they haven’t overpaid for assets once again.

Always Optimistic

But optimism is certainly one commodity that Wall Street always has in abundance. When it comes to earnings expectations, estimates are always higher regardless of the trends of economic data. As shown, Wall Street is optimistic the current earnings decline is just a blip on the way to higher-highs.

As of April 2019, when Wall Street first published their estimates for 2020, the expectations were that earnings would grow to $174.29 by the end of next year.

The difference between Wall Street’s expectations and reality tends to be quite dramatic.

You can see the over-optimism collided with reality in just a few short months. Since April, forward expectations have fallen by more than $11/share as economic realities continue to impale overly optimistic projections.

Unfortunately, estimates are still too high and have further to fall. It is very likely, particularly if “tariffs” remain in place into 2020, that the majority of expected earnings growth will be reversed.

(This shouldn’t surprise you. We previously warned that by the end of 2018, the entirely of the “Trump Tax Cut” benefit would be erased.)

The Ugly

This divergence in stock prices not only shows up in operating earnings but also in reported corporate profits. As noted previously, the deviation between prices and profits is at historically high levels which cannot be sustained indefinitely.

“If the economy is slowing down, revenue and corporate profit growth will decline also. However, it is this point which the ‘bulls’ should be paying attention to. Many are dismissing currently high valuations under the guise of ‘low interest rates,’ however, the one thing you should not dismiss, and cannot make an excuse for, is the massive deviation between the market and corporate profits after tax. The only other time in history the difference was this great was in 1999.”

While the market has rallied sharply in 2019 on continued “hopes” for a “trade deal,” and more accommodative actions from the Federal Reserve, the deviations from fundamentals have reached extremes only seen at peaks of previous market cycles.

The chart below shows the real, inflation-adjusted, profits after-tax versus the cumulative change to the S&P 500. Here is the important point – when markets grow faster than profitability, which it can do for a while; eventually a reversion occurs. This is simply the case that all excesses must eventually be cleared before the next growth cycle can occur. Currently, we are once again trading a fairly substantial premium to corporate profit growth.

Since corporate profit growth is a function of economic growth longer term, we can also see how “expensive” the market is relative to corporate profit growth as a percentage of economic growth. Once again, we find that when the price to profits ratio is trading ABOVE the long-term linear trend, markets have struggled, and ultimately experienced a more severe mean-reverting event. With the price to profits ratio once again elevated above the long-term trend, there is little to suggest that markets haven’t already priced in a good bit of future economic and profits growth.

While none of this suggests the market will “crash” tomorrow, it is supportive of the idea that future returns will be substantially weaker in the future.

Currently, there are few, if any, Wall Street analysts expecting a recession currently, and many are certain of a forthcoming economic growth cycle. Yet, at this time, there are few catalysts supportive of such a resurgence.

• Economic growth outside of China remains weak

• Employment growth is going to slow.

• There is no massive disaster currently to spur a surge in government spending and reconstruction.

• There isn’t another stimulus package like tax cuts to fuel a boost in corporate earnings

• With the deficit already pushing $1 Trillion, there will only be an incremental boost from additional deficit spending this year. 

• Unfortunately, it is also just a function of time until a recession occurs.

Wall Street is notorious for missing the major turning of the markets and leaving investors scrambling for the exits.

While no one on Wall Street told you to be wary of the markets in 2018, we did, but it largely fell on deaf ears as “F.O.M.O.” clouded basic investment logic.

The next time won’t be any different.

Late last Wednesday, with hours left until the Thanksgiving holiday, Trump signed the controversial Hong Kong bill, knowing well it would upset Beijing and risk an escalation in the trade war, however as we said, “it appears the president was confident enough that a collapse in trade talks won’t drag stocks too far lower” with the S&P just hitting an all time high above 3,150. Since then, the assessment that Trump was confident enough that a resumption in trade hostilities wouldn’t have too negative of an impact on the market has only been borne out, resulting in Trump launching new trade war fronts in both Latin America and Europe, and this morning, appearing to hammer the final nail in any trade deal with China in 2019, and perhaps ever, when he said it may be better to wait for a trade deal until after the 2020 election.

The news promptly sent US equity futures tumbling below the critical 3,100 level where there is a mountain of dealer gamma, and where negative convexity means selling will beget more selling.

Meanwhile, China also decided to remind Trump that it would have a say in the matter, and moments ago the Global Times directly accused the US of “backpedaling”, but noting that it was prepared for such as “worst case scenario”, to wit:

The US appears to be backpedaling in #tradetalks as officials threaten tariff hikes, but that will have zero effect on China’s stance because Chinese officials have long prepared for even the worst scenario: Mei Xinyu, an expert close the Chinese Commerce Ministry.

The US appears to be backpedaling in #tradetalks as officials threaten tariff hikes, but that will have zero effect on China’s stance because Chinese officials have long prepared for even the worst scenario: Mei Xinyu, an expert close the Chinese Commerce Ministry pic.twitter.com/P7Ai3NYXdO

— Global Times (@globaltimesnews) ٣ ديسمبر ٢٠١٩

 

And just in case the complete collapse in diplomatic relations was lost on someone, moments ago the director of the Chinese foreign ministry Hua Chunying compared Mike Pompeo to a mentally ill woman.

CN Spokeswoman Hua Chunying called Pompeo “Xianglin Auntie” (祥林嫂) today, quoting a character from Lu Xun novel to paint Pompeo, who criticized IP theft, as a mentally illed woman who keeps repeating stories. It’s tone deaf af even by China standards. Literature breakdown: 1/n pic.twitter.com/Hght7FM9yJ

— Toni (but what’s your *real* name?) (@tony_zy) December 3, 2019

In any case, the rapidly deteriorating back and forth sent futures to another sharp leg lower, now well below 3,100…

… and the risk is that the record VIX short position we have been warning about, is about to see a historic squeeze.

Last week, when Trump signed the Hong Kong bill, we asked if Trump was willing to reignite the trade war now that the S&P hit an all time high of 3,150.

That question was especially apt this morning, when European shares slumped back into the red on Tuesday, reversing an earlier attempt to claw their way back from three days of falls, US equity futures tumbled for the second day in a row and the Chinese yuan sank on renewed trade tensions after President Trump said at the start of his British NATO summit visit that a that a trade deal with China might be delayed until after November 2020 elections, denting hopes of a quick resolution to a dispute that has weighed on the world economy.

“I have no deadline, no. In some ways, I think I think it’s better to wait until after the election with China,” Trump told reporters in London, where he was due to attend a meeting of NATO leaders. “In some ways, I like the idea of waiting until after the election for the China deal. But they want to make a deal now, and we’ll see whether or not the deal’s going to be right; it’s got to be right.”

Those comments, made as Trump landed in Britain for a NATO summit, also sent the offshore-traded Chinese yuan to near five-week lows.

France, the latest U.S. trade war target, saw shares tumble more than 0.6% to a one-month low, and dragged Europe’s Stoxx 600 index down 0.2%, giving up earlier modest gains and extending Monday’s 1.6% tumble which was its biggest one-day loss in two months.

U.S. stock futures also turned negative, with S&P 500 futures down 0.4%.

“The markets were spooked because they didn’t expect Trump to be that severe on China,” said WisdomTree researcher Aneeka Gupta. “It’s worrying for Europe too, because it was waiting for a decision on the auto tariffs from the U.S. Investors weren’t expecting Trump to be launching trade wars on all fronts.”

Trump’s willingness to open new fronts in the trade war – with Argentina, Brazil and France – despite signs of economic damage and less than two weeks away from the China tariff deadline, spooked markets. Indeed, his latest comments dashed hopes that an agreement with China could be reached before another round of tariff hikes kicks in on Dec. 15, and suggests talks could in fact could drag on for another year.

As Reuters notes, markets had fallen sharply on Monday after Trump tweeted he would slap tariffs on Brazil and Argentina for what he saw as both countries’ “massive devaluation of their currencies.” The United States then threatened duties of up to 100% on French goods from champagne to handbags because of a digital services tax that Washington says harms U.S. tech companies.

“Each step back and each step forward is just part of a slow trend toward increased barriers to international trade,” said Jonathan Bell, CIO of Stanhope Capital. “The market’s taken an optimistic view so far this year on the likelihood of a successful outcome to trade negotiations and we worry … the market may turn back to being more concerned.”

Shares in some French luxury goods firms had been hit hard, with LVMH shedding almost 2% to one-month lows and champagne maker Vranken Pommery down 0.5%. “If history is any guide the Europeans are likely to find U.S. crosshairs start to move increasingly their way, the closer to next year’s U.S. election we get,” CMC Markets told clients.

As a result, the MSCI world equity index was down for the fourth day in a row to one-week lows. There were also hefty losses across Asian bourses earlier in the day, led by consumer staples firms, tracking U.S. declines. Most markets in the region were down, with Australia leading losses and China advancing. Japan’s Topix slid, dragged down railway companies and automakers. The Shanghai Composite Index reversed morning losses to close higher, as Ping An Insurance Group and Will Semiconductor offered support. Two Chinese companies failed to repay bonds worth a combined half a billion dollars Monday, as debt risks rose in a slowing economy. India’s Sensex declined, with ICICI Bank and HDFC Bank among the biggest drags.

Meanwhile, investors were waiting for even more shoes to drop and China’s next response: Beijing has already barred U.S. military ships and aircraft from Hong Kong in response to U.S. support for pro-democracy protesters in the Chinese-ruled territory. Fears that the prolonged tariff spat will snuff out any upturn in global growth were fanned on Monday when the U.S. ISM report said manufacturing had contracted for a fourth straight month as new orders slid. That crippled the cheer from upbeat Chinese factory surveys as well as higher-than-expected manufacturing and inflation readings from the euro zone.

So with trade suddenly in limbo, hopes are now being pinned on the U.S. consumer to keep the economy afloat. Cyber Monday sales were expected to hit a record following $11.6 billion in online sales during the Thanksgiving and Black Friday shopping bonanza.

In rates, Trump’s hints of trade deal delays sent bond yields tumbling as investors dumped stocks, however, with 10-year U.S. Treasury yields falling 5 basis points to 1.79% from the previous day’s two-week high, despite a sharp selloff in Japanese bonds following a report that Tokyo is preparing a 25 trillion yen fiscal package, which in turn resulted in the worst bid to cover in the Japanese 10Y auction in three years.

German bond yields slipped off three-week highs but bond prices are likely to stay under pressure amid renewed risks of early elections or a minority government in the biggest euro zone economy.

The safe-haven bid was seen across FX too, with the yen at a one-week high to the dollar. The euro edged away from a near two-week peak versus the greenback, while the dollar reversed losses after Trump’s statement. “This may have run its course, but there’s no reason to chase the dollar’s upside from here,” Daiwa Securities’ foreign exchange strategist Yukio Ishizuki said, noting that the weak manufacturing data had forced many to cut long dollar positions. “Trade friction remains a lingering threat, which is not good for market sentiment.”

Elsewhere, oil fluctuated as traders gauge the probability of OPEC and allied producers tightening supplies when they meet later this week. Australia’s dollar rose after upbeat comments on the global economy by its central bank, while its government bonds dropped.

Looking at the day ahead in the US, the only data due out are the November vehicle sales numbers. Away from the data, we’re due to hear from the ECB’s Coeure and Hernandez de Cos. Elsewhere the NATO conference kicks off in London. Salesforce and Workday are among companies reporting earnings.

Market Snapshot

• S&P 500 futures down 0.3% to 3,103.50
• STOXX Europe 600 up 0.4% to 402.40
• MXAP down 0.4% to 164.17
• MXAPJ down 0.4% to 522.79
• Nikkei down 0.6% to 23,379.81
• Topix down 0.5% to 1,706.73
• Hang Seng Index down 0.2% to 26,391.30
• Shanghai Composite up 0.3% to 2,884.70
• Sensex down 0.3% to 40,676.21
• Australia S&P/ASX 200 down 2.2% to 6,712.29
• Kospi down 0.4% to 2,084.07
• German 10Y yield fell 0.4 bps to -0.285%
• Euro down 0.01% to $1.1078
• Italian 10Y yield rose 11.7 bps to 1.002%
• Spanish 10Y yield fell 0.9 bps to 0.481%
• Brent futures little changed at $60.96/bbl
• Gold spot up 0.6% to $1,470.47
• U.S. Dollar Index little changed at 97.78

Top Overnight News from Bloomberg

• ECB officials face increasing pushback against their negative interest-rate policy in private engagements with the region’s finance ministers, according to people with knowledge of the matter
• Pacific Investment Management Co. has become the latest high-profile critic of negative interest rates, warning that one of the key central-bank tools in economically beleaguered Europe and Japan may do more harm than good
• The ECB’s shift in net asset purchases to corporate bonds may become a more lasting and self- fulfilling feature of this QE leg, as it expands the shopping list while encouraging new issuance
• France’s government said the EU would retaliate if the U.S. follows through on a threat to hit about $2.4 billion of French products with tariffs over a dispute concerning how large tech companies are taxed
• At a summit in Brussels next week, EU leaders will commit to cutting net greenhouse-gas emissions to zero by 2050, according to a draft of their joint statement for the Dec. 12-13 meeting. To meet this target, the EU will promise more green investment and adjust all of its policy making accordingly
• After five years of negative rates imposed by the ECB, German lenders are breaking the last taboo: Charging retail clients for their savings starting with very first euro in the their accounts
• The Bank of Thailand said measures taken so far to curb capital inflows are “baby steps” and policy makers have plenty of tools available to deploy to curb the currency’s strength

Asian equity markets retreated amid headwinds from the US where the major indices all but wiped out last week’s gains due to fresh trade concerns with lacklustre ISM Manufacturing data also adding to downbeat tone. ASX 200 (-2.2%) and Nikkei 225 (-0.6%) were lower with underperformance in Australia due to hefty losses across its sectors including financials amid continued Westpac-related woes and with life insurers facing increased capital penalties, while sentiment in Tokyo was dragged by the adverse currency flows. Hang Seng (-0.2%) and Shanghai Comp. (+0.3%) also weakened on the trade uncertainty (although the latter pared losses heading into the close) with some analysts reading in between the lines of the metal tariff resumption on Brazil and Argentina, suggesting that it could be another front in the trade war following the nations’ recent agricultural deals with China. In addition, China’s retaliation to the Hong Kong bill by sanctioning US non-profit groups and barring US military visits to Hong Kong, as well as expectations for the US House to pass a Xinjiang-related bill further exacerbated the already-opaque trade environment. Finally, 10yr JGBs failed to take advantage of the widespread risk averse tone, as prices remained dejected following the recent bond rout and with selling also triggered after the 10yr JGB auction showed weaker results across all metric including the lowest b/c since August 2016.

Top Asian News

• Japan’s GPIF Stops Lending Shares in Blow to Short Sellers
• Dalio Out of Favor at Asia Wealth Manager as Flagship Fund Falls
• Hong Kong Economist Says His Views on China Cost Him His Job
• Nomura Sets Ambitious China Hiring Plans as Rebound Persists

Major European bourses (Euro Stoxx 50 Unch) are mixed, having reversed earlier gains US President Trump said that there was no deadline on a China deal, and that it may be better to wait until after the November 2020 Presidential Election to strike a deal. Elsewhere, some underperformance is being seen in the FTSE 100 on unfavourable currency effects, while the CAC 40 is being weighed by under performance in some of its heavy weight luxury names, Kering (-1.4%), LVMH (-1.4%) and Hermes (-1.9%), on US/EU trade concerns after the US responded to France’s digital sales tax.Meanwhile, sectors are mostly in the red, apart from Utilities (+0.4%), Tech (+0.5%) and Healthcare (+0.1%). In terms of individual movers of note; easyJet (-0.5%) shares were initially higher on the news that the Co. is set to return to the FTSE 100 and will replace Hiscox (-1.3%), although gains have since reversed. Elsewhere, Telenor (+1.2%) was buoyed by an upgrade at Citigroup. Laggards include Aston Martin (-5.5%), who sunk after being downgraded to neutral from buy at Goldman Sachs.

Top European News

• German Banks Open Floodgates to Negative Rates for all Savers
• ECB Sub-Zero Rate Policy Faces Pushback From Finance Ministers
• Italy’s Agnellis Add La Repubblica Publisher to Media Assets

In FX, both outperforming in the G10 FX sphere, more-so the Aussie in the aftermath of the RBA’s latest monetary policy meeting in which the Cash Rate was left unchanged. Key themes in the statement were largely a copy-and-paste job from recent meetings which repeated the gentle turning point in the economy but reaffirmed data dependency and the readiness to inject further stimulus if needed. However, desks note of a slightly more positive tone in the statement which linked rising house prices to a potential lift in spending and residential construction. AUD/USD extends its gains above the 0.6800 level and surpassed its 100 and 21 DMA (at 0.6818 and 0.6820 respectively) to a current high of 0.6860 (vs. low of 0.6815) with clean air until the psychological 0.6900 mark. The Kiwi piggybacks on its antipodean partner’s gains and covers more ground above the recently claimed 0.6500 level vs. the USD to a high of 0.6530 ahead of its 200 DMA at 0.6544.

• GBP, EUR – Sterling rose in the G10 ranks in early European hours after the retrieval of 1.2950+ status vs the Dollar spurred upside momentum (amid potential stops/orders), and with tailwinds from the latest election Kantar poll (showing a widening gap between Tories and Labour) underpinning the currency in recent trade. Cable rose to a current high of 1.2994 after eclipsing its Nov 18th high (1.2985) with eyes remaining on election developments as election day looms. Meanwhile, the Single Currency held onto most of its gains vs. the Buck despite France’s growing trade tension with the US which prompted the latter to propose duties of up to 100% on certain French imports. EUR/USD meanders around the middle of a tight 1.1072-1.1086 intraday band, ahead of potential resistance at 1.1097 (Nov 21st high), with little impetus derived from ECB Board nominees and sources reports of pushback on the ECB’s NIRP by EZ finance ministers.
• DXY, JPY, CNH – The broad Dollar and Index resumes their downward trajectories following yesterday’s dismal manufacturing prints and with little by way of fresh fundamental catalysts. DXY hovers around the bottom of today’s current 97.74-94 range with little on the today’s docket in terms of tier 1 data. Meanwhile, USD/JPY convincingly fell below the 109.00 mark (to a low of 108.84 vs. high 109.20) after US President Trump signalled no rush for a US-Sino trade deal. USD/JPY also sees hefty options of around USD 1bln expiring between strikes 109.00-10 and a further USD 1bln at 109.50. Subsequently, USD/CNH was bolstered to fresh session highs of 7.0690 (vs. low of 7.0360) in light of Trump’s comments on trade.
• EM – The EM space trades mostly on the backfoot with the Rand underperforming as South Africa’s economy contracted on a QQ basis, missing expectations for modest growth. USD/ZAR took out its 200 DMA to the upside (14.5772) to a high of 14.6900 with little seen by way of resistance ahead of 14.7000. Meanwhile, the Lira recovered from initial loses which emanated from US senators urging Secretary of State Pompeo to sanction Turkey over its purchase and testing of the Russian-made S-400 system. The TRY has since pared back a bulk of its losses as President Trump continues to support Turkey.

In commodities, crude markets are flat/higher and off best levels, as risk assets take a hit following the latest US President Trump’s trade comments. However, price action remains well within yesterday’s ranges; technicians will be eyeing resistance at the USD 56.65/bbl and USD 62.10/bbl levels and support at the USD 55.65/bbl and USD 60.78/bbl levels for WTI Jan’ 20 and Brent Feb’ 19 futures (yesterday evening’s trading range). Crude specific news flow has been light; Russian Energy Minister Novak said that Russia is yet to finalise their position for OPEC+ meeting in Vienna, which takes place at the end of the week. Amid rumours that OPEC+ are considering up to an additional 400k bpd in production cuts, the Russians are known to have been resistant to further cuts, instead preferring an extension of existing cuts until mid-2020. In terms of the metals, gold gained as risk soured, with the yellow metal briefly advancing above USD 1,470/oz from overnight lows of USD 1,460/oz. Meanwhile, trade concerns are hitting copper; the red metal has slumped from overnight highs of USD 2.6550/lbs to near USD 2.6300/lbs lows. , Iron Ore prices gained overnight after its largest miner, Vale, lowered its production outlook. On Monday, the miner said that it would cut output from it Brucutu mine in Brazil for up to two months while the stability of the nearby Laranjeiras dam in assessed.

US Event Calendar

• Wards Total Vehicle Sales, est. 16.9m, prior 16.6m

DB’s Jim Reid concludes the overnight wrap

In the last 24 hours we’ve gone from a potential Santa Claus rally to a more Scrooge-like environment as the ghost of trade wars past came back to haunt the market. Indeed sentiment took a hit following President Trump’s tweet that tariffs would be reinstated on steel and aluminium from Argentina and Brazil and then on Commerce Secretary Ross telling Fox that President Trump will increase tariffs on China if nothing happens between now and December 15th. That undid some of the good work from the majority of global PMIs released earlier in the day. However, a weaker US ISM manufacturing print did bring in an element of doubt and confusion to the picture.

More on the data shortly but first off President Trump’s tweet that “Brazil and Argentina have been presiding over a massive devaluation of their currencies which is not good for our farmers” and that “effective immediately, I will restore the tariffs on all steel and aluminium that is shipped into the US from those countries”. The President followed with the Fed “should likewise act so that countries, of which there are many, no longer take advantage of our strong dollar by further devaluing their currencies”.

The implications of President Trump’s tweet is important less for the direct economic impact and more because it shows the current state of President Trump’s thinking on tariffs, and thus the read-through to China. The latter came into play after Ross’ comments with the markets taking another leg down after the headlines hit. These were partially alleviated by subsequent comments from White House advisor Kellyanne Conway, who said that a deal is possible before year-end. So a fair bit resting on the next couple of weeks ahead of the December 15 tariff increase deadline. However, some reports have suggested they could still be suspended even without a deal, as long as productive talks are continuing. Nevertheless, this date is creeping up on us and something has to happen before it one way or another. Later in the day, and separately, the USTR said that it will consider higher tariffs on the EU to compensate for subsidies given to Airbus, citing a WTO ruling, though the dollar amounts under consideration are small.

After all this, the NASDAQ and trade-sensitive semi-conductor indices closed down -1.12% and -1.46%, respectively. The S&P 500 and DOW fared slightly better but still closed down -0.85% and -0.96%, while the VIX climbed to 14.64 and to the highest level since mid-October. European equities fared even worse, with the STOXX 600 ending -1.58%, its worst session since 2nd October. The DAX and CAC were down -2.05% and -2.01%, and the V2X mirrored the VIX by rising +2.72pts to 15.89.

Overnight the Global Times said that the Chinese government will soon publish a list of “unreliable entities” that could lead to sanctions against US companies. China had originally threatened to publish the list in May in response to the restrictions the US placed on Huawei. The timing seems to be linked to an accelerated US House of Representatives vote – expected today – on the Xinjiang bill, which was passed by the Senate in September. This could put sanctions on officials linked to alleged abuses of Uighur Muslims. It remains to be seen whether this will impede the path towards the Phase 1 deal, which according to President Trump yesterday has already been complicated by the signing of Hong Kong bill into law.

Elsewhere, after the US markets closed last night, Bloomberg reported that the US is proposing tariffs on roughly $2.4 bn in French products, in response to a tax on digital revenues that hits large American tech companies including Google, Apple, Facebook and Amazon. The office of the United States Trade Representative said in a statement that “France’s digital services tax discriminates against U.S. companies.” USTR Robert Lighthizer added that the agency is also exploring whether to open investigations into similar digital taxes by Austria, Italy and Turkey before saying that, “the USTR is focused on countering the growing protectionism of EU member states, which unfairly targets US companies.” The tariffs would be imposed after a public comment period concludes in early 2020. As we write this on a cold December morning it doesn’t feel like the global trade problems are going to thaw anytime soon.

A quick refresh of our screens this morning shows that most Asian markets are trading lower with the Nikkei (-0.72%), Hang Seng (-0.18%), Shanghai Comp (-0.04%) and Kospi (-0.43%) all down. However, most indices are off their intraday lows. As for FX, the Australian dollar is up +0.41% this morning after the RBA held its key interest rate unchanged and highlighted that past easing is having an impact. Yield on 10y USTs are up +2.1bps while those on 10y JGBs are up +3.3bps to -0.028% as demand for the benchmark debt fell at an auction. Elsewhere, futures on the S&P are up +0.18%.

In other news, Hong Kong’s Chief Executive Carrie Lam said overnight that the government would soon announce new moves to prop up the city’s flagging economy without giving any details of what those measure would be. She just mentioned that the measures would be “targeted.” Yesterday, Financial Secretary Paul Chan said that he expected the first fiscal year budget deficit since the early 2000s, and said that the turmoil has dragged down economic growth by some 2pp this year. Elsewhere, North Korea reiterated overnight that the US has until the end of the year to make a better offer in nuclear negotiations, saying the “Christmas gift” the US receives will depend on what it brings to the table.

The bond sell-off overnight follows a similar move yesterday where 10y Treasury yields rose +4.5bps. Front-end rates rallied though, possibly pricing in slightly higher odds that the Fed will end up having to cut again next year. Two-year yields fell -1.0bps, taking the yield curve +5.7bps steeper to 21.7bps. Bunds sold off +8.0bps to -0.284% after the shock weekend SPD news (updates below). Other European bond markets followed the German move, with OATs and Gilts +7.8bps and +4.1bps, respectively. BTPs underperformed, with 10-year yields up +11.9bps, as investors de-risked.

Alongside the SPD news, the earlier decent PMIs seemed to kick start the bond sell-off. In terms of the PMIs, after China’s beat, the PMIs in Europe saw the Euro Area manufacturing print revised up 0.3pts to 46.9. That is the second consecutive monthly increase – something that hasn’t happened since 2017, which is a stunning stat – and also to the highest reading since August. Half of the increase came from Germany and France – the former revised up to 44.1 and the latter to 51.7. Also encouraging was the fact that all of the key components – including new orders, new export orders and employment – saw slight upward revisions. The outright level of the PMI is still clearly a concern but it still lends an argument to seeing a stabilisation in the data.

In the afternoon the US manufacturing PMI was revised up 0.4pts to 52.6, which matches the April levels once again. However, to complicate the picture, 15 minutes later the November ISM manufacturing missed at 48.1 (vs. 49.2 expected). You could argue that the data has stabilised somewhat – the reading was only down 0.2pts from 48.1 and remains above the 47.8 low print from September. That being said, the gap to the PMI (and regional fed surveys) is muddying the waters. In addition, the details didn’t add much encouragement with new orders down to 47.2, employment down to 46.6 and new export orders down to 47.9.

Coming back to yesterday where the fallout from the SPD leadership election in Germany played out with German Finance Minister Scholz, despite losing the leadership bid, announcing that he will still attend a meeting of Eurozone finance ministers tomorrow. Our German economists published their thoughts post the election in a note yesterday, which you can find here . In their view, the vote for Walter-Borjans and Esken increased the probability of the Groko falling apart but does not translate into an automatic or immediate collapse of the government coalition. Their baseline view remains that the new party leaders and delegates at the SPD’s December 6-8 party conference will support a (possibly conditional) continuation of the Groko until the 2021 elections and that the SPD will not pull out of Groko immediately. Still, as the CDU/CSU are reluctant to renegotiate the Groko treaty, non-negligible risks of a premature end to the government coalition remain. It must be said that the internal debate within DB continues to be around how much more likely it is that fiscal spending eventually increases as a result of this political shockwave. There is little doubt that the chances have increased but the timing and scale of any policy changes are still up for much debate.

Elsewhere, new ECB President Lagarde testified to the European Parliament for the first time in her new position, but did not reveal any major policy details. She promised that policy will “continue to support the economy and respond to future risks in line with our price stability mandate.” She refused to prejudge the planned policy review, saying that the “direction and timeline” of the process is still to be determined. This tempers any expectations for near-term policy moves by the ECB, including at this month’s meeting. Notably, Lagarde did talk more about “the side effects of our policies,” which has thus far been the biggest departure from Draghi’s rhetoric and likely signals reduced appetite to cut the deposit facility rate deeper into negative territory.

To the day ahead now, which this morning includes Q2 labour costs and the November construction PMI in the UK and October PPI for the Euro Area. In the US the only data due out are the November vehicle sales numbers. Away from the data, we’re due to hear from the ECB’s Coeure and Hernandez de Cos. Elsewhere the NATO conference kicks off in London.