Drive-By Macro Themes For Q4

by: Samantha LaDuc

Expectation is that the cycle of RATE – OIL – WAGE- INFLATION – RATE spikes is just beginning.

Passive Investing in FAANG is like walking with elephants. They seem passive enough but every twitch must be watched, guarded against. A stampede – unstoppable power in its destruction.

In 2016, stocks yielded substantially more than bonds which helped fuel their rally; today, it's the other way around.

Macro Themes for Q4

Bulls and Bears are both wrong – as laid out ‘clearly’ in this Schwab Market Perspective.

EM may be Emerging Soon: The divergence between US gain and Emerging Market/China losses are striking. In fact, the EEM relative under-performance vs SPX has only been surpassed less than 1% of the time since 2000. This could soon mean that EM is a buy.

China and Yuan Devaluation Risks: Big picture, markets are still uncertain about Trade Wars with China, even if NAFTA is negotiated to a close with both Mexico and Canada.

JP Morgan sees weaker China Currency, Trade War escalation: Now expects the yuan to drop to 7.01 per dollar by the end of December and 7.19 by September 2019, after previously projecting it at 7.00 in 12 months’ time.

Rate Spike and the US Dollar: The USD has decoupled from the rising 10-year yields of late, so I will be watching with great interest if this continues as it is a sign of ‘internal’ market stress and more to the point ensuing volatility. For the most part, I still expect trade tariffs to impact US profit growth, earnings and lead to price inflation. An Oil Spike will fuel inflation which can ignite even more Rate Spikes.

Dollar Break With Yields Prompts Concern U.S. Has Funding Issue

FAANG Stress: Valuations in $AAPL and $AMZN are not justifying the premium in their stock prices.

As bond yields rise, future cash flows thrown off by FAANGs are far less attractive. During the February bond yield surge, FAANGs dropped 12-14%. All these ETFs are a bit like shadow banks. They are like the CDOs on the eve of the financial crisis. @Convertbond Lawrence McDonald

What about all those passive ETFs that hold predominately FAANG stocks you ask? It’s like walking with elephants I suppose. They seem passive enough but every twitch must be watched, guarded against. A stampede – unstoppable power in its destruction.

Volatility: VIX is known historically to make a strong showing in October.

Bonds Over Equities: Bond prices are falling which is pushing up yields, and as such equities will be less attractive. In 2016, stocks yielded substantially more than bonds which helped fuel their rally; today its the other way around.

At 3.5% the 10-year has upside risk if the term premium reverts higher as a result of QT. According to my calculations, the 10-year could end up at 4.0% if this happens. In fact, the recent move higher in real rates hints at a coming reset for the term premium. Jurrien Timmer of Fidelity

BuyBacks: We enter, albeit briefly, the buyback blackout period prior to Q3 Earnings Reports. For the record books, we just hit $189 billion in Q2 stock buybacks which was up 60% YOY. With that kind of volume, you’d think the market would be higher!

Buybacks help boost stock price for some companies – like $AAPL – but not all! For example, $BBBY has spent over $8.5 Bn on share repurchases over the last 10 years, about 4x the current market cap. If you look at a chart you will see their price is down 80% from the highs, prompting the question why they didn’t invest that money in their business instead.

Earnings Expectations: Both higher expected and real rates, combined with slower global growth and 3Q negative guidance could prompt those perennial bullish analysts to lower SPY expectations. Then what will investment managers do?

Only ~110 or so S&P companies issue guidance these days. But of the 98 that have, more than 3/4 are negative pre-annoucements — the highest percentage in nearly 3 years. (via @FactSet @TommyThornton)

Oil Spike: I saw price action post EIA inventories on 9/19 when WTIC was $70 that caused me to flip from Short to Long Crude. Originally I thought Trump’s threatening tweets would effectively lower Oil prices into the November Elections in order to avoid being blamed for the rise in oil prices that are a byproduct of his sanctions on Iran – which are ironically going into effect about the same time as the US elections.

Refiners have carried on processing at elevated rates well after the end of the normal summer driving season and into September in order to rebuild previously depleted distillate stocks. But the now-plentiful supply of gasoline and to a lesser extent distillate implies refiners will have to cut processing more sharply than usual over the next couple of months to avoid creating a glut of refined products. John Kemp, Reuters

Higher yields can drag commodities higher which is why after I called for a RateSpike call on 9/2- now up 38 bp, I made the call for an Oil Spike 9/19 and neither has disappointed. I see mounting technical price action and macro backdrop that is pointing to a continuation of higher rate and oil prices well into next year.

Options volumes were 2:1 bullish and the highest ever via Bloomberg as oil traders see $100 oil.

But then….

I wouldn’t be surprised by:

Europe’s Bad Timing: Fully expecting ECB to hike next year about the same time we experience another $100 oil shock in Brent.

And Let’s Not Rule Out an Oil Bust After the Boom:

Imposing artificially higher prices on the world through supply management always backfires. Daniel Lacalle

The risk? Prices not based on fundamentals eventually go bust.

And not just for oil...

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.