Volume 22, Issue 33
October 15, 2018.
Source: Globe & Mail
Douglas Porter, CFA
BMO Chief Economist
Last week’s focus on rising yields and a potential bear market in bonds morphed into an entirely different layer of concern this week. In an echo of February’s swift correction, equities were pummelled by a rapid two-day descent, which hit almost all sectors and almost all major bourses. By Thursday’s close, the S&P 500 found itself down 6.9% from the record high reached a mere three weeks earlier, while the Nasdaq was 9.6% below its late-August peak. Similarly, European markets ended the week down by almost 5%, even with a modest global bounce on Friday, while Asian markets took a bigger haircut—China’s main index fell almost 8%, while the Nikkei sagged 5.3% on the week.
Naturally, armchair detectives were out in force after the hit, looking for who/what was responsible for the swift turn of events. The President seemed to have little doubt, railing against the Fed’s tightening campaign over a 24-hour period. Running the gamut of calling the Fed “crazy”, “loco”, “ridiculous”, and “wild”, he also opined that “I think they are making a big mistake”. While far from a helpful intervention into the middle of a market maelstrom, most saw the rants as a continuation of earlier tirades in the summer and a fairly transparent effort to pin the blame elsewhere. Suffice it to say that it’s a minority opinion in the markets that the Fed’s rate hikes qualify as “crazy”—by the standards of any past tightening cycles, this one stands out as particularly leisurely at 200 bps spread over almost three years and starting at extremely low levels.
Still, while we have no quarrel with the Fed’s moves so far, there is little doubt that rising rates are making life less comfortable for markets, in general, and equities, in particular. Recall that one of the smoking guns behind the February correction was also a rapid rise in long-term yields, which saw the 10-year Treasury surge 50 bps in a matter of weeks at the start of the year to nearly 3%. This latest episode saw 10s run more than 40 bps up from their late August lows to a peak on Tuesday of nearly 3.25%.
But that primary suspect was already backing away from the crime scene even before stocks began to swoon, as yields dipped this week on calmer oil prices, a benign U.S. inflation result, and the market turmoil. The September CPI printed just 0.1%
on both headline and core, holding the latter steady at a 2.2% y/y pace and trimming the 3- and 6-month trend to just 1.8% annualized. We suspect core inflation will grind higher in the year ahead, but the recent mild results reinforce the view that the Fed will not need to go “wild” (i.e., crank up the pace of rate hikes). Having said that, we remain quite comfortable looking for the Fed to continue bumping up rates by a quarter every quarter until the middle of next year. A flurry of Fed
speakers this week cast little doubt on that view, with even the normally dovish Charles Evans chiming in that rates needed to get back to neutral, and soon.
The other prime suspect for the market downdraft was the rumbling trade battle with China. Beyond Treasury yields, markets have also been warily eyeing the steady rise in the US$/yuan exchange rate in recent weeks. Matching bonds, it also peaked early this week at just over 6.93/US$, a rise of more than 10% from the lows in April—just as trade hostilities first broke into the open. News late last week that the U.S. bilateral trade deficit hit a new record high of $397 billion in the past 12 months piled on. However, there was a double-dose of late-week relief on this front. News of a potential November meeting between Trump and Xi alongside indications that U.S. Treasury staff believe that China is not manipulating the yuan turned down the heat on the conflict.
A third factor weighing on markets was a dimming global outlook for 2019 and any potential impact on earnings next year. The IMF’s semi-annual global outlook saw a small trim to both this year’s growth estimate and a shave to next year as well. The latest forecast was, in fact, unsurprising, given the strains in a variety of emerging markets, the weight of trade wars, and less-loose monetary policies globally. In that environment, the surprise would be if global growth did not cool over the next year. Following last year’s synchronized and solid global GDP growth of 3.7%, we now look for 3.6% this year and another small step down to 3.5% in 2019. True, that’s slower—but it’s not slow.
Meantime, back at the U.S. economy, a sparse week for data (aside from CPI) left Treasuries largely driven by the air pocket in stocks. We continue to believe that the domestic growth outlook is firm, with Q3 GDP likely to come in at 3% and staying
close to that mark over the next two quarters as well. Amid all the market noise, keep in mind that we are looking for growth of 2.5% next year, inflation of little more than 2%, and a jobless rate of less than 4%; true, some of the cheery news comes
courtesy of a budget deficit of almost $1 trillion over the next year, but the overall economic backdrop remains highly favourable.
Have a great week.
Frank & Mark
Source: Globe & Mail, BMO Capital Markets, Bank of Canada
Canada’s stock benchmark held up better than the major U.S. indices, because of relative strength in the materials and health care sectors. Materials were lifted by the safe haven flows that boosted gold prices to a two-month high. With less than a week to go before marijuana legalization, shares of cannabis companies advanced after Altria (the maker of Marlboro cigarettes) was reported to be in talks to buy a stake in a Canadian cannabis producer. Defensive sectors – utilities, staples and real estate – were also outperformers. The information technology sector, especially sensitive to the threat of international trade disruptions and slower global growth, was among the worst performers. Energy shares dropped, alongside falling oil prices. Year-to-date, the TSX is down 4.9% and the benchmark 10-year yield was slightly lower ending the week to yield 2.49%.
Equities around the world dropped this week after the yield on U.S. 10-year treasuries peaked briefly above 3.25%, its highest level since 2011, and investors began to worry interest rates were approaching levels that would prove restrictive to economic growth. Amidst the week’s turmoil, Toronto’s S&P/TSX Composite Index had its worst single-day point drop in more than three years, the Dow Jones Industrials suffered its third biggest one-day point drop in history, and the technology-heavy NASDAQ saw its worst daily plunge in seven years. Weaker than expected inflation data prompted treasury yields to settle back a little, slowing the descent. Then an easing in U.S.-China trade tensions helped allow equity markets a partial recovery on Friday. Year-to-date, the S&P 500 is up 3.50%, the Dow Jones Industrials are up 2.5%, and the Nasdaq is up 8.6%. The yield on the 10 year Treasury closed at 3.15%.
Source: BMO Capital Markets
The Good: Building Permits +0.4% (Aug.); New Housing Price Index unch (Aug.).
The Bad: Housing Starts -5.1% to 188,683 a.r. (Sep.).
The Good: Consumer Prices +0.1% (Sep.); Producer Prices +0.2% (Sep.); Wholesale Inventories revised up to +1.0% (Aug.); NFIB Small Business Optimism Index -0.9 pts to 107.9 (Sep.).
The Bad: Import Prices +0.5% (Sep.); Initial Claims +7k to 214k (Oct. 6 week); U of M Consumer Sentiment
-1.1 pts to 99.0 (Oct.).
Vandal who put googly eyes on Georgia monument sought
SAVANNAH, Ga. — A Georgia city is searching for a vandal who put googly eyes on a historic monument.
A post on the City of Savannah Government Facebook page asks: “Who did this?! … It may look funny but harming our historic monuments and public property is no laughing matter, in fact, it’s a crime.”
Police spokeswoman Keturah Greene says police are investigating the incident involving the Nathanael Greene Monument, which was reported Thursday.
Greene was a major general in the Continental Army during the Revolutionary War, and is buried in Johnson Square near his monument.
The Savannah Morning News reports criminal trespass is a misdemeanour offence in Georgia. However, if the damage is more than $500, it’s a felony called criminal damage to property.