There is a light — a month end respite for shares

Michael Mackenzie

Mike Mackenzie’s daily analysis of what’s moving global markets

Mike Mackenzie’s daily analysis of what’s moving global markets

Equity markets are ending a brutal October on a note of relief. We are also seeing a breakout in the US dollar, at its best level since June last year, and firmer nominal and, more importantly, real yields on Treasuries, so any respite for risk assets may prove fleeting. You can mention there being light at the end of a tunnel only to prompt a classic trader’s riposte — “yeah but is that the light of an oncoming train?”

A challenging month that has seen Wall Street lose altitude and the S&P 500 index briefly join global equities in negative territory for the year will resonate for some time. There are reasons for optimism from here as the US market is now cheaper and recession risk — the true killer of bull markets — remains low. But one nagging concern is that we have not seen a true capitulation moment that typically confirms a floor in the market. So watch the dollar, the renminbi and that 10-year real yield (back around 1.10 per cent) from here as we negotiate November. 

After Apple’s earnings tomorrow, the focus will turn to the US employment report due on Friday. A robust reading for jobs and wage growth — expected to rise at a 3.2 per cent annual pace for October — will keep the Federal Reserve on course for more tightening in December. A reminder that we have a Fed meeting next week, with the policy statement unlikely to deviate from that of September, even after the recent market turmoil. 

Here’s Paul Shea from Miller Tabak & Co:

“The Fed will view the stock market slump as a normal correction unless other financial indicators, such as credit spreads, deteriorate.”

Today’s equity bounce has been global — shrugging off weak Chinese data — and caps the worst month for the FTSE All-World index since 2012, with the woe for leading benchmarks and other asset classes highlighted below. The S&P has endured its toughest monthly shellacking since September 2011, while the Nasdaq has not suffered this degree of pain since November 2008.

Not surprisingly, measures of implied volatility for both the S&P 500 (Vix) and Treasury bonds (Move) have risen notably. There has been a further divergence between US and German bond yields. The 10-year Bund, like gold, has been a haven in October, as Italy’s budget spat with the EU has cast quite a shadow over the eurozone. 

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As we end the month, the yield on the US 10-year Treasury note remains below its recent peak of 3.25 per cent, but the 10-year real yield is near its recent high. The dollar index rose earlier today above its previous high from August, for a monthly gain of 2 per cent, its best result since May.

The JPMorgan Emerging Market currency index slipped in October, but we have seen Argentina, Turkey and Brazil rally strongly. In the red zone, Mexico’s peso is ending October at a four-month low as investors turn ahead of president-elect Andrés Manuel López Obrador taking office as recounted here by the Financial Times.

As I have said before, further weakness in China’s renminbi is the big currency story and the economic news today was hardly soothing as the country’s official manufacturing purchasing managers’ index arrived on the softer side at 50.2, and just above contraction territory. New export orders fell to 46.9 from 48.0. The other interesting development was news today that the People’s Bank of China will sell Rmb20bn ($2.9bn) of bills in Hong Kong’s offshore renminbi market. The bills will soak up liquidity and make it more expensive to bet against the currency.

Treasury yields and the dollar rose after today’s US data showed an acceleration in private sector wages and salaries during the third quarter versus a year ago — 3.1 per cent and a new cycle high. The strength of hiring in the US was illustrated as ADP private sector payrolls rose by 227,000 for October. Of course the ADP is not a good predictor for the official US payroll report. 

Here’s MFR’s Josh Shapiro:

“The NFIB survey sub-component that queries small business owners about their plans in terms of compensation changes provides a pretty good leading indicator of the [employment cost index, or] ECI private wage and salary measure. The NFIB measure is signalling accelerating gains in wages and salaries in the months ahead, although as the chart below illustrates, the relationship is one of trend rather than identical movements.”

Quick Hits — What’s on the market radar

Eurozone earnings season — More misses than beats for the first time in four years says Morgan Stanley and they add “margin weakness and cost inflation have driven the weakness”.

The bank writes:

“From a sector perspective misses have been worst in healthcare, consumer discretionary, telecoms and industrials while energy and IT have been strongest.”

Sales have so far been in line, but earnings per share is showing the first net miss since the fourth quarter of 2014.

Pound rises off the floor — After inching below $1.27 and near the lows of August, the pound bounced after Brexit secretary Dominic Raab told MPs that Britain’s exit deal with the EU should be finalised within three weeks. The move soon lost steam and pound’s mid-month high of $1.32 does look very distant. 

Another central bank under political pressure — Relations between India’s government and the Reserve Bank are fraught as the country deals with defaults among its non-banking financial sector. The FT writes how a reported threat by the bank’s governor Urjit Patel to resign over government interference prompted an unusual statement as India’s finance ministry acknowledged that central bank autonomy was “an essential and accepted governance requirement”.

US Treasury quarterly debt refunding — No real surprises here. The Treasury will sell $83bn of new coupon debt next week, up from $78bn back in August, as the rising US deficit pushes up borrowing needs. The Treasury Inflation Protected Securities market will also have a new issue, but one that arrives a year from now. The US Treasury will introduce a new October five-year Tips maturity starting in 2019. The Treasury plans for a gradual increases in Tips issuance start after the February 2019 refunding and says this reflects rising borrowing needs and is consistent with the recommendation from dealers and investors “that Tips should remain around 7 per cent of gross issuance”.

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