The market is going great so no need to worry, right?

The market is going great so no need to worry, right?


There are weeks when sitting down to write this piece is tough because not much worthy of note has happened in the markets or the economy outside of the usual noise. This week, that was most definitely not the case. Thank God it is Friday – we all need a break.


New Market Highs and the Economy Gets Uglier

Thursday the S&P 500 closed at a new all-time high and is now above its 50-day, 100-day and 200-day moving averages. The post Federal Reserve Open Market Committee meeting debrief gave the market essentially what it wanted, a significantly more dovish stance with plenty of reasons to believe future rate cuts are imminent. Perhaps the Marty Zweig adage, “Don’t fight the Fed,” has been flipped on its head to “Fed, don’t fight the markets.” Unemployment is at multi-decade lows with more job openings than unemployed persons, rising hourly earnings, and improving retail sales while the market hits all-time highs and yet the Fed is preparing to stimulate. Yeah, something’s off here.

Stocks may be partying like it is 1999 (for those who remember that far back) but the yield on the 10-year closed at 2.01% Thursday. To put that in context, on June 9th when the 10-year was down to 2.09%, the Wall Street Journal ran an article asserting that, “Almost nobody saw the nosedive in bond yields coming, but a few players were positioned well enough to profit. Some think there is more room for yields to fall further,” along with this chart. To be clear, despite not one respondent predicting the yield on the 10-year would fall below 2.5% in 2019, none of these economists are idiots, but the thing is they all tend to read from the same playbook.

The stock market is giddy over its expectations for lower rates, yet the spread between the 3-month and the 10-year Treasury has been inverted for four weeks as of this writing, not exactly a ringing endorsement for economic growth prospects. Every time this curve has been inverted for 4 consecutive weeks, it has been followed by a recession (hat tip @Saxena_Puru) for this chart. Note that the chart uses 10-year versus 1-year until the 3-month became available in 1982. Much of the mainstream financial media and fin twit believe this time is different. Time will tell.

The red arrows denote 4 consecutive weeks of inversion and the blue arrows mark bear-market lows (20% declines).

Then there is this, with a hat tip to Sven Henrich whose tweet with a chart from Fed went viral – that in and of itself says a lot.

Both US imports and exports have declined from double-digit growth in 3Q 2018 to essentially flat today. The recent CFO Outlook by Duke’s Fuqua School of Business found that optimism about the US and about their own companies amongst CFO’s had fallen from the prior year.

The shipments of goods being moved around the country have plummeted since the beginning of 2018, as shown by the Cass Freight Index.

The Morgan Stanley Business Conditions Index fell 32 points in June, the largest one-month decline in its history.

If all that doesn’t have your attention, consider that the New York Fed’s recession probability model puts the probability that we are in a recession by May 2020 at 30%. Note that going back to 1961, whenever the probability has risen to this level we have either already been in a recession or shortly entered one with the exception of 1967 – 7 out of 8 times.

But hey, the market is going great so no need to worry right? If that’s what you are thinking, skip this next chart from @OddStats.


Geopolitics – From Bad to Oh No, No No

Brinksmanship with Iran continues as in the early hours of Friday we learned that the US planned a military strike against Iran in response to the shooting down of an American reconnaissance drone. The mission was called off at the last minute after the President learned that an estimated 150 people would likely have been killed. Frankly, the official story sounds a bit off, but what we do know is that we are in dangerous territory and one can only hope that some cooler heads prevail, and the situation gets dialed back a whole heck of a lot.

Given we weren’t enjoying enough nail-biting out of the Middle East news, an independent United Nations human rights expert investigating the killing of Saudi journalist Jamal Khashoggi is in a 101-page report recommending an investigation into the possible role of the Saudi Crown Prince Mohammed bin Salam citing “credible evidence,” and while not specifically assigning blame to bin Salam, did assign responsibility to the Saudi government. This week the US Senate voted to block arms sales to Saudi Arabia, rebuking the President’s decision to use an emergency declaration to move the deal forward. This matters when it comes to investing because there are some seriously high-stakes games being played out that have the potential to suddenly rock markets without any warning.

Over in Europe more and more data points pointing to a slowing economy, which led to European Central Bank President Mario Draghi to announce that more stimulus could be in the works if inflation fails to accelerate. At the ECB’s annual conference in Sintra, Portugal Draghi stated that, “In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required.” It isn’t just inflation that is troubling the region. Euro Area Industrial Production (ex Construction) has only seen increases in 2 of the last 11 months.

Italy continues to struggle with its budget deficit outside the limits allowed by the European Union, leading to a battle between Rome and Brussels. Friday Deputy Prime Minister Matteo Salvini (head of the euro-skeptic Lega party) threatened to quit his position if he is not able to push through tax cuts for at least €10 billion. While the US has been laser-focused on the Fed (and the president’s tweets) the Italian situation is getting more tense and a time when UK leadership with respect to Brexit is also getting a lot more tense. To put the Italian problem in perspective and understand why this problem is not going away, look at the chart below.

Today, Italy’s per capita GDP is 2.8% BELOW where it was in 2000 while Germany is 24.8% higher. Even the beleaguered Greece has outperformed Italy. Italy’s debt level is material to the rest of the world, its economy is material to the European Union, its citizens are losing their patience and its leadership consists of a tenuous partnership between a far-right, fascist-leaning Lega and a far-left, communist(ish) 5 Star movement lead by folks that very few in the nation respect. So that’s going well.

As if the European Union didn’t have enough to worry about as its new parliament struggles to find any sort of direction or agreement on leadership, the parliamentary process for selecting the next Prime Minister of the UK is down to two finalists. Enthusiam is rampant.

A hard Brexit is looking more likely and that is not going to be smooth sailing for anyone.


The Bottom Line

All this is a lot to take in, but there is a bright light for the week. Anna Wintour, Vogue’s editor-in-chief and eternal trend-setter, has given flip-flops her seal of approval. So, we’ve got that going for us. If that didn’t put a little spring into your step, I suggest you check out this twitter feed from Paul Bronks. Your soon-to-be more swimsuit ready abs will thank me, but your neighbors will wonder what the hell is going on at your place.

Ukraine – Why and What’s Next

Ukraine – Why and What’s Next

As if things in Europe aren’t complicated enough, the situation in Ukraine is getting more troubling by the day. The turmoil there is having vast geopolitical impacts that are keeping the investing world as nervous as a long-tailed cat in a room full of rocking chairs. Here’s the quick, errrrhhh, fair enough, as quick as a verbose Irish lass can get, version of how we got to today.

 

In late 2013, Ukrainian President Viktor Yanukovich was expected to sign some agreements that could eventually integrate Ukraine with the European Union economically. Ultimately, he refused to sign the agreements, a decision thousands of his countrymen immediately protested. Demonstrations eventually broke out with protesters calling for political change. When Yanukovich resisted their calls, they demanded new elections. Eventually the protestors won, Yanukovich was forced to flee the country and now we have a nation in flux.

 

So why does anyone outside of Ukraine, population 44.6m and with 233k square miles, care? Ukraine is central to Russian defenses, sharing a long border with the former Soviet Union and more importantly, Moscow sits all of 300 flat and easily traversed miles from Ukraine. Therefore, from a Russian perspective a tighter Ukrainian-EU integration represents a threat to Russian national security. Putin appears to be disinterested in actually governing Ukraine, but rather his goal seems to be to effectively have negative control, the ability to prevent Ukraine from doing anything Russia dislikes. With that in mind, it appears that even the very idea of further EU integration was provocation enough for Putin. The European Union’s and the Germans’ public support for opponents of Yanukovich crossed his red line.

 

From a European perspective, Ukraine isn’t quite as interesting. Economically the Eurozone wasn’t enamored with having the nation join the EU, it just liked the possibility of such. Adding a country as weak and disheveled as Ukraine to an already strained union didn’t make much sense, but the idea of the possibility someday is attractive. The talk about joining was really more about inviting Ukraine to make a cultural shift towards Europeanism, with a constitutional democracy and a more liberalized economy. Germany found itself between the proverbial rock and a hard place as it continues to work with Russia on its mutual energy and investment interests while trying to manage coalitions within the European Union, particularly attempting to appease the Baltic States and Poland who would like to see Ukraine closer to them and further from the Russian camp, giving them an additional buffer.

 

The U.S. strongly supported the Orange (anti-Yanukovich) Revolution, siding with the Germans and the Eurozone, which was no doubt going to get under Putin’s skin; but then the U.S. owed him one after the Snowden situation. Throughout history, many of the global conflicts, and for that matter noteworthy familial brawls, have been catalyzed by the little things.

 

The situation has evolved into a tense standoff between the G7 nations and Russia. On March 12th, the U.S. Department of Energy announced that it would draw down from the U.S. Strategic Petroleum Reserve in what it claimed was a “test sale to check the operational capabilities of system infrastructure.” In reality, this was a warning shot fired at Putin. Later that same day Bloomberg reported that the U.S. has escalated the situation even further, with General Martin Dempsey, the Chairman of the Joint Chiefs of Staff, claiming that “in the case of an escalation of unrest in Crimea, the U.S. Army is ready to back up Ukraine and its allies in Europe with military action.” The G7 has threatened sanctions against Russia if it continues, with the U.S. Congress passing a resolution on March 11th to work with European allies and others to “impose visa, financial, trade and other sanctions” against key Russian officials, banks, businesses and state agencies. In a quick tit-for-tat, Russia responded on March 13th that it is prepared to retaliate with sanctions of its own against the west. Germany responded to this by announced that Angela Merkel is prepared to cancel a summit with Russia if Moscow does not help to defuse the situation.

 

To add a little extra flame to the fire, Iranian Oil Minister  arrived in Moscow late March 13th to meet with Russian Energy Minister Alexander Novak and Deputy Prime Minister Igor Shuvalov, IRNA reported. Namdar-Zanganeh will discuss ways to deepen economic cooperation between the countries, because there weren’t nearly enough strained relationships!

 

Militarily things are also nail-biter as around midnight on March 5th the Russian navy used tugboats to maneuver a 9,000-ton hulk of a mothballed anti-submarine cruiser into the inlet to Crimea’s Donuzlav Lake, effectively blocking access to the sea from Ukraine’s primary naval installation on the peninsula. Reportedly seven of the Ukrainian’s twenty five ships are trapped, picture at left.

 

According to the Ukrainian Defense Ministry, on Saturday March 15th, Ukrainian forces repelled an attempt by Russian troops to land in the southern Ukrainian region of Kherson Oblast. The landing reportedly occurred on Arbatskaya Strelka, a long spit of land running parallel to the east of Crimea. Earlier, it was reported that four Russian military helicopters deployed around 60 Russian troops near the town of Strilkove, forcing around 20 Ukrainian border guards and servicemen to retreat from their positions. Later in the day Ukrainian and Russian defense ministries announced a truce in Crimea until March 21st. Anyone else feel like renting Red Dawn (the original of course)?

On Sunday March 16th, the people in the Crimean region reportedly voted to have Russia annex Crimea by an overwhelming majority of some 95%+. On Monday the EU announced that it would impose travel bans and asset freezes on 21 Russian and Ukrainian officials that are considered central to Crimea’s move to separate from the Ukraine. The U.S. issued sanctions as well, via an executive order signed by the President, to freeze the assets of and ban visas for seven Russian officials and four Ukrainians.

 

Tuesday the Kremlin announced that it had officially annexed Crimea, which could be the most dangerous geopolitical event of the post-Cold World era. The two most likely outcomes are:

  1. Russia will quickly prevail, gaining the power to redraw its borders and set the precedent for exercising veto powers over the governments of its neighbors or,
  2. Western-backed Ukrainian government will push back and the second-largest country by area in Europe will descend into a Yugoslav-style civil war that will likely pull into its turmoil, Poland, NATO and eventually the U.S.

 

An alternative outcome is unlikely as Putin cannot at this point give up Crimea. It would mean a publicly shaming on a global level that could destroy his presidency.

 

Bottom Line: This situation has the potential to rock the markets, which are for now keeping a wary eye. Europe desperately needs Russian fuel. London and much of Europe is greatly beholden to the nouveau riche Russians for their highly demonstrative consumption of luxury goods and services, which only adds more pressure. There’s even a reality TV show called “Meet the Russians” which follows the lives of some ultra-bling Russians who are buying up Britain and “setting a new benchmark for extravagant living.” Europe can’t afford to push too hard back against Russia, but they also cannot ignore a precedent for unfettered Russian aggression. It is impossible to predict exactly how this will play out, but close attention is warranted.