Yesterday’s violent reversal in the S&P which followed a dreadful non-manufacturing ISM (which in turn followed a dismal manufacturing ISM print just days earlier), confirmed that once again “bad news is good news” for the market (although today’s market reaction to the lukewarm payrolls report in turn suggested that both bad and good economic news is good news for the market, but we digress).
To be sure, there has been more than enough chatter of an upcoming global recession, which as has been the case for much of the past year, has fallen across what BofA’s CIO Michael Hartnett calls the 3Cs: China, Consumer and Credit And whereas “China” plays i.e. global manufacturing, are already in recession; neither US “Consumer” (watch unemployment claims) nor “Credit” markets (watch spreads) in recession; but both Consumer & Credit now appear to be “as good as it gets” and investors substantially crowded “length” in both themes.
Some more details:
China: China led global manufacturing into recession. As BofA writes, the recent EU/Asia/manufacturing data is “a recession rollcall” – Sweden PMI – a global trade barometer -crashing to 46.3 …
… German orders @ 44.3, US ISM @ 47.8, China auto sales plunging -13%, India auto sales crashing -10%, Hong Kong retail sales tumbling a record -25%, Japanese consumer confidence @ 8-year low. The reason: for all its efforts to spark a credit impulse recovery, Beijing has failed. The reason: China now has too much debt.
Consumer: current gulf between US consumer optimism & US business pessimism has been rarely exceeded (Chart below); more ominously, most prior peaks – 1980, 1989, 1998, 2001 all pre-recession, recession, or credit event years; to Hartnett, this means that payrolls are now key “but the next recession begins once unemployment claims surge 50k.”
Credit: US ISM at 47.8 is also an ominous sign for credit spreads (last time ISM this weak HY spreads were 700-800bps not 400bps, see Chart below);
BofA predicts that credit event fears will rise if there is a disorderly rise in US dollar (DXY>100) which would hint at a liquidity crisis; meanwhile most Wall Street leading indicators are negative: IPO ETF (IPO), broker-dealers (XBD), private equity (PSP) breaking down; in summary, the “next recession begins once yield curve steepens and credit spreads rise and bank stocks fall”, Hartnett concludes.
If this cocktail of bad news was not enough, there was even more bad news: plugging the BofA Global EPS model forecast of -6% (based on global PMIs, Asia exports, yield curve, China FCI), vs a -3.3% consensus…
… into US EPS results in a $165 EPS, which gives S&P500 range of 2555 (in case fears about policy/political impotence cuts the PE multiple to 15.5x) to 2888 (if aggressive Fed boosts PE expansion to 17.5x).
And yet, as we noted as the very beginning, this avalanche of bad news is now so powerful… it has become good news.
Why? Because it means investors have to look forward to “policy panic”, which would look as follows: Fed starts cutting 50bps, Trump “pivots” on trade tariffs, US intervenes to weaken $, China/German fiscal stimulus.
As a result, whereas Hartnett sees “nice weather for bears” as the Oct recession reality reverses Wall St gains in Sept “he is staying contrarian bullish credit & stocks”… which is ironic considering
And since China’s credit impulse is unlikely to regain its upward momentum – simply because China no longer has the credit capacity to inject as much debt as it did over the past ten years – a “policy panic” response this year is assured, with BofA proposing the following ideas on how to trade it:
- Buy Chinese equities to play Trump pivot on tariffs
- Buy EM stocks should weak payroll “top” the US dollar (EM growth stocks are cheapest versus US growth stocks since 2002 – Chart below)
- Buy US homebuilders as Fed cuts accelerate
- Buy US exporters as US$ devalues
- Buy EAFE small cap as Germany bows to inevitable fiscal stimulus post-Brexit
- Buy UK mid cap stocks as end to Brexit ends multi-year pessimism on UK assets
- Hedge recession via long 2-year Treasuries (125bps above 2011 lows) and gold
- Hedge recession via selling US consumer and global credit proxies into strength
… or said otherwise: “Policy panic trades: buy China, EM, US housing, EAFE small cap, UK mid cap; hedge via long GT2, gold.”
Finally, as we enter the final – and most turbulent – quarter of the year, here is a summary of the top trading catalysts known as of today:
- Q4 trading catalysts:
- Oct 10th: China Vice-Premier Liu He in DC for resumed trade talks
- Oct 15th: US set to raise tariffs 5 percentage points on $250bn Chinese imports
- Oct 17th-18th: EU summit
- Oct 24th: ECB meeting
- Oct 30th FOMC
- Oct 31st: potential “no deal” Brexit
- Nov 7th: potential EU fiscal stimulus announcement
- Nov 13th: US/EU auto tariff decision
- Nov 17th: Huawei US exports exemption expires
- Dec 11th: FOMC