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Largest Surge in Seven Years from China’s Manufacturing PMI
As the March economic data starts to come in from China, in the week ahead – that sound you’ll be hearing will be a loud sigh of relief coming out of the global bond market.
China Stimulus Arrives on Stage
In Q4 2018, China threw a substantial amount of fiscal and monetary weaponry at its weakening $13T economy. Heading into the trade negotiating climax with the USA, we believe tax cuts and PBOC RRR (levels of reserves in their banking system) activity – all together – come to over $500B of stimulus. Three months later, those desperate measures are showing up in the data.
Upside Surprise
To us, the meaningful upside surprise in China’s March NBS Manufacturing PMI speaks to near term positive momentum for the industrial activity outlook for all of Asia. A trade deal with the USA will only add to these positive developments. China will extend the 3-month suspension of additional tariffs on US-made vehicles and auto parts, which expires on March 31, 2019, the tariff committee of the State Council said on Sunday.
Brent Oil likes the Data Coming Out of China
We’re seeing a Major trend breakout oil on the heals of the China PMI bounce – bullish wedge.
Negative Yield Bonds and Gold
In Q1 2019, the global economy’s struggles have powered the tally of negative yielding bond on earth to near $10T. Economic data out of China this weekend will likely turn this ship around.
Good News from China for Bond Bears
China March official composite PMI +1.6pts to 54 driven by manufacturing +1.3pts to 50.5 and non-manufacturing +0.5pts to 54.8. Could partly reflect lunar near year holiday distortions but also likely reflects the impact of China stimulus measures. “A Positive sign for Chinese and global”growth,” says AMP Capital. China delivered good news for global investors this weekend. This year, the country’s struggling demand had weighed on sectors such as auto producers and commodity exporters, worldwide – especially Germany. Likewise, with tariffs and uncertainty about whether a deal with the U.S. will be signed weighing on trade and no sign of a rebound in domestic consumption yet, there is still some work to be done in terms of getting more “buy-in” from the global investment community.
New Data is a Colossal Relief
In its largest surge since 2012, China’s manufacturing purchasing managers index rose to 50.5 from 49.2 last month, exceeding all estimates by economists – the consensus was looking for 49.6. In better news, new orders and new export orders – leading indicators which signal future activities, popped up to the highest levels in six months. Keep in mind, Germany’s economy and bond yields have a very high beta to China’s economic fortunes. As you can see above, over the last 5 years lows in German bond yields have been closely tied to periods where China’s Manufacturing PMI struggles. This speaks to HIGHER global bond yields in the days and weeks to come – a bounce is long overdue.
China Equities Moving North – Bullish Wedge Break
Major markets in Asia surged on Monday following data released over the weekend that showed economic activity in China unexpectedly bouncing back in March. Mainland Chinese shares soared on the day, with the Shanghai composite up 2.58 percent to 3,170.36, while the Shenzhen component surged about 3.64 percent to 10,267.70. The Shenzhen composite jumped 3.571 percent to 1,755.67.Over in Hong Kong, the Hang Seng index was up 1.66 percent in its final hour of trading. – CNBC
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RBC Capital Markets lowers its 12-month price target on shares of Tesla amid softer demand expectations and a delivery snag in China – new target is a 14 percent reduction to his prior forecast and implies more than 20 percent downside over the next year from Friday’s close. “We see both 2019 and 2020 revenue as down vs. the 4Q18 run-rate and, given Tesla is priced for growth, believe the valuation will come in” – 
Japan led off this week where US equities closed out last, in the red. The 3% plunge is equivalent to 765 dow points.
In recent years, U.S. equities in the economically sensitive consumer discretionary XLY sector have substantially outperformed consumer staples XLP (82.6% vs. 47.9% over the last five years total return). Since June 2018, the world has changed – staples XLP have had their day in the sun (red channel above). During Friday’s 500 point swoon in the Dow Jones Industrial Average, the XLY was 2% lower – while defensive equities in the XLP were unchanged – a sign of things to come. What’s the connection here between what bonds and equities are telling us?
When Fixed Income markets start to price in a cap on near term / intermediate term bond yields, floating rate securities begin to dramatically under-perform (bank loans BKLN).
Since October, the 2-10s US Treasury curve has flattened from 34 to 11bps. Since March 18, the XLF Financials ETF has plunged nearly 7%, the KBW Nasdaq Bank Index of large lenders posting its biggest one-week slide since 2016, off 10.6% since Tuesday – all with the staples XLP up 1%. Sure, we all know banks’ earnings power struggles with a flat curve and the follow on pressure on net interest margins. But, is this downdraft in the financials simply a product of a flattening yield curve? Or is something more ominous afoot?
Yields on U.S. investment-grade bonds have plunged to the lowest in more than a year.
German 10-year bonds were up at 0.57% in October, they touched -0.01% this week – their lowest yield since 2016. The last time bond yields in Europe were this low the ECB was buying $60 to $80B a month of asset purchases vs. just $5 to $10B today.
We have an economist (above – white line) that’s actually worth listening to. As you can see above – going back 30 years – well before U.S. recessions, consumer staples dramatically outperform consumer discretionary stocks. When we take a close look at a recession-proof sector like the staples XLP ETF vs. a sector with a high degree of economic sensitivity, consumer discretionary XLY – we come up with eye-opening data. Notably, this ratio has historically rolled over before yield curve inversions as well. Historically, yield curve inversion only confirms what Stan’s economist is already telling us. For our full report, join 
Since 1990, the 3 Month / 10 Year yield Curve has inverted twice. During 2000 to 2002 and from 2006 to 2008. Staples outperformance was substantial in these periods.
Above, is the peak to which staples outperforms the S&P 500 post-inversion. If it was a fight, they’d stop it. In a late cycle, post “yield curve inversion” regime, investors want to be overweight consumer staples – and underweight the S&P 500. Bottom line, the key lessons from previous cycles must be listened to:
Credit risk in Europe has tightened substantially since the beginning of the year. However, the CDS in Deutsche and Commerzbank remains well above the banks in the US. 
Our Larry McDonald with hall of fame historian Niall Ferguson in Manhattan Friday. The Debt Jubilee, see our latest sit down on Real Vision 
We often tell clients, “credit leads equities.” Even more important, tightening financial conditions (FCIs) drive Federal Reserve policy movements, NOT lagging economic data. Nearly every economist in the U.S. was calling for 2-3 rate hikes back in October / November – even as financial conditions were tightening at the fastest pace since 2015. By focusing on FCIs, in late Q3 2018, we were able to position clients in a basket of “Fed Pause” trades (emerging markets, energy, gold) – this thesis has played out beautifully.
The very latest reading of the core PCE index, rose 0.19%, its largest monthly gain since May. Prices for services, more sensitive than goods to domestic labor supply / wages, surged 0.29% – the largest jump in nearly 15 months. It’s also interesting to note how much bonds have rallied with sharply lower yields in U.S. Treasuries, while core PCE inflation is still up meaningfully over the last 18 months and NOT giving up any ground (see the white circle above).
Just when the Street gave up on reflation and the rate cut camp started to overflow – bonds put in the most significant sell-off since Q2 2018 in recent days. It’s looking more and more like China hit the panic button heading into the trade negotiations. They were dealing from a position of weakness with an economy reeling from the sharpest global slowdown in decades. The mountain of fiscal and monetary policy actions they’ve taken is nothing short of remarkable. RRR cuts, tax cuts, infrastructure spending splurge. Looks like an $800B boost to the German economy 🙂 – maybe global synchronized growth will appear on stage after all?
Economic boost: This will help Xi’s team sitting across the table from Uncle Bob (U.S. trade hawk) Lighthizer.
The CDX IG is the most followed measure of corporate credit conditions in the U.S., we’re looking at the credit spreads on large investment grade companies above. As you can see, credit conditions tightened dramatically, and then the senior loan officer survey caught up with what the CDX IG was telling us weeks earlier. The Fed pays close attention to the loan survey data above, unfortunately, it takes forever to compile the STALE data. The survey above is the most recently available, as of January 31, 2019, but the actual engagement with loans officers was compiled in Q4. The white line above is telling you current credit conditions are easing, and easing fast relative to the now “out of date” C&I loan survey data.
Here’s a look at the S&P 500 and Fed Chair Powell’s posture on global financial conditions. With a splash of hubris, we’ve been lectured for nine months that the Fed is going to “stay in our lanes, the U.S. economy.” The latest shift from “Not Concerned” to “Concerned” has global equities moving higher. Since 2010, through all their denials, ultimately global financial conditions (FCIs) have been driving the Fed policy path NOT U.S. economic data, the Fed made a colossal shift this week.
The Richmond Fed manufacturing survey for December came in exceptionally weak; -8 vs +15 expected. This is the lowest level since June 2016. This is yet another data point showing economic momentum in the U.S. slowing down, which will eventually be helpful in pushing the Fed to back off on rate hikes. The Markit Manufacturing PMI print came in slightly below expectations on Wednesday, however, the ISM Manufacturing PMI released Thursday morning was a massive miss. Working with our associates at Astor Ridge, we expected the ISM PMI to come in well below expectations and calculated it could be as low as 54.0. Regional PMIs had seen substantial misses in the past two weeks and though the market was pricing in a significant drop from 59.3 to 57.5, it seemed to be overlooking the surprisingly poor regional data prints. Above are listed the Dallas, Philadelphia, New York, Richmond, and Kansas City Factory gauges, the dotted line is too close for comfort, recession territory.
One thing driving the Federal Reserve and the bond market crazy is the whacky disconnect between U.S. wages (AHE in white above) and the global economy’s downward pressure on bond yields (see the U.S. 10 year yield in yellow above). Bonds are in rally mode with lower yields in part because of a large supply of workers, U.S. labor force slack. There are far too many young people NOT in the labor force to generate sustainable inflation. Friday, the unemployment rate rose to 3.9% from 3.7% because the labor force increased by 419k. That’s real size 
The combination of rate hikes and balance sheet reductions from the Federal Reserve in 2018 sucked up global U.S. dollar liquidity and put emerging markets under immense pressure. Next, the collateral damage forged onto the global economy took U.S. stocks lower in Q4. In our view, so far the Fed’s $400B balance sheet reduction vacuumed $1T out of the banking system. Through 2018, foreign banks – size holders of excess reserves – have been forced to search for other funding sources. The unintended consequences here are all over the floor. Globally, borrowing costs for consumers have surged with short term money market yields. The economic destruction is far more than meets the eye, the Fed is clearly walking in the dark here and they can’t find the light switch.
Emerging market equities were 20-30% lower from February through October, bonds (credit markets) didn’t fare much better (see above), next the S&P played catch up to the downside. This, combined with tariffs from the White House has placed global manufacturing in a significant slowdown that has begun to circle back into the United States. After all, over $60T of global GDP is OUTSIDE the USA.
All-time highs in U.S. equities just so happen to be perfectly timed with global central bank candy (asset purchases) fleeting into negative territory. Offshore dollar debts worldwide have ballooned to $12.8T (BIS data). Roughly $4T of contracts outside the US are priced off three-month Libor rates alone, which have doubled over the last year. Rate hikes matter, the Fed balance sheet reduction matters more, pure global economic impact.
The market is giving the Fed the “Rodney Dangerfield, “No Respect.” The Fed’s ability to hike rates further in 2019 is in doubt above. Not only are U.S. 2 year yields BELOW the upper bound of the Fed Funds rate, but this week futures were pricing in a higher probability of a rate cut than a rate hike in 2019. 
There are a number of ways to bet against Fed rate hikes, most efficient is trading EuroDollar futures. One of our best trade ideas issued to clients in the fourth quarter of 2018 was buying Gold and Silver miners. In our view, precious metals are powerful tools to take advantage of a Fed that has been too hawkish. Since October 1st, the probability of ANY Federal Reserve hike has completely caved. Meanwhile, since August, the GDX gold miners ETF is up +23.1% while the SIL Silver Miners ETF is +15.2% higher with the S&P 500 off nearly 15%. Pick up 
