Across the Curve

San Francisco Fed On Slow Growth as the New Normal

Interesting article by John Fernald of the Research Department of the San Francisco Fed. He writes that the New Normal means real GDP growth between 1.5 and 1.75 percent. The result will be lower wages, less growth in tax revenue and a lower neutral funds rate. Here is an excerpt and a link to the full piece.

Via the San Francisco Fed:

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Overnight Preview

Via Robert Sinche at Amherst Pierpont Securities:

CHINA: Over the next week, the Bberg consensus expects the monetary report will show continued strength in Aggregate Financing at CNY1,390bn versus a solid CNY1,469.7bn in August. The improvement would likely reflect solid loan growth as fiscal stimulus takes hold.

AUSTRALIA: Reflecting stabilization of growth through the Asia region, Consumer Confidence has inched irregularly higher over the 18 months, although still at very subdued levels; the index was 101.4 in September.

S. KOREA: The Bberg consensus expects the UR held steady at 3.8% in September, although the trend has been decidedly higher since late 2013, and reduced phone production may impact the economy in the months ahead.

JAPAN: The Bberg consensus expects August Machine Orders to have fallen -4.7% MOM after 4.9% jump in July, but that would still allow the YOY increase to increase to 7.9% from 5.2% in July.

EURO ZONE: The Bberg consensus expects that Industrial Production in August jumped back 1.5% MOM after a -1.1% drop in July, which would bring the YOY rise to 1.5%, strongest since April.

FRANCE: The Bberg consensus expects the final EU Harmonized CPI to be confirmed at 0.5% YOY in September, strongest in 2 years.

UK: The Bberg consensus expects the RICS House Price Balance will inch up again to 14% in September from 12% in August and a cycle-low 5% in July.

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Saudi Arabia Finances

Saudi Arabia will soon visit the markets with a huge bond issue. This Bloomberg story highlights the risk inherent in that issuance ( to investors) as enumerated in the prospectus.

Via Bloomberg:

Four Highlights From Saudi Arabia’s 220-Page Bond Prospectus
2016-10-11 14:37:00.273 GMT

By Matthew Martin and Anthony DiPaola
(Bloomberg) — As Saudi Arabia prepares to meet investors
with a view to selling its first international bonds, the
country has disclosed little-known information about its
economy. Here are four statistics that caught our eye today.

1) Oil Income Plunged About 70% in 5 Years

Saudi Arabia relies on oil for three-quarters of its
income. Crude revenue has slumped 68 percent since 2011 to 334
billion riyals ($89 billion) this year amid a supply glut.
The slide in prices accelerated after OPEC adopted a Saudi-
led strategy in 2014 to allow members to pump as much as they
wanted to protect the group’s market share and drive higher-cost
producers out of business. As oil swamped the market, prices
fell to a 2003 low of about $28 a barrel in January.
The Organization of the Petroleum Exporting Countries
agreed last month to cut output to support crude, which traded
over $50 a barrel this month.

2) Spending Cuts

The kingdom slashed capital expenditure by more than 70
percent this year to 75.8 billion riyals. Current spending,
including salaries and government services, is forecast to
decline 19 percent.
The cuts mean that investments in infrastructure projects
will drop to less than a tenth of government spending, from
about a third in 2011. The government has delayed payments to
contractors and is weighing plans to cancel more than $20
billion of projects, people familiar with the matter said last
month. It has also suspended bonuses and trimmed allowances for
government employees.

3) Government Debt is Rising Fast

Saudi Arabia has been selling domestic bonds for over a
year to fund the largest budget shortfall among the world’s 20
biggest economies. Debt has ballooned more than six times since
the end of 2014 to 273.8 billion riyals as of the end of August,
according to the prospectus.
Most of the debt is domestic. In the first eight months of
the year, the government raised 94 billion riyals from the sale
of government bonds to local banks and institutions, and it
raised 98 billion riyals last year, according to the prospectus.
It has a $10 billion sovereign loan that was signed in May. It’s
set to start meeting investors on Wednesday for the dollar bond.
Public debt levels will increase to 30 percent of economic
output by 2020 from 7.7 percent, according to targets set out in
an economic transformation plan released in June.

4) PIF Will Cut Back on Lending

Since it was created in 1971, the Public Investment Fund
has focused on lending to development projects in the country.
Outstanding loans by the PIF, as the fund is known, rose to 104
billion riyals at the end of 2015, from 57 billion riyals at the
end of 2011, according to the prospectus. In the future, the PIF
“will not act as a source of lending to the same extent that it
has historically,” according to the document.
Transforming the PIF from a lender on domestic projects
into the world’s largest sovereign wealth fund is a key part of
Saudi Arabia’s plans to diversify the economy away from oil. The
government is looking to sell less than 5 percent of national
oil company Saudi Aramco in an initial public offering and
transfer ownership of the rest of the company to the PIF. The
shift will give PIF assets of more than $2 trillion and will
technically make investments the main source of government
revenue, not oil, Deputy Crown Prince Mohammed bin Salman told
Bloomberg in March.
There is a long way to go. The fund had assets of 587
billion riyals as of June 30, and received more than 20 billion
riyals in dividends, mostly from its holdings of Saudi Arabian
equities, including Saudi Basic Industries Corp. and National
Commercial Bank, according to the prospectus.

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Slow Down Your Moving Too Fast

That is what Simon and Garfunkel said in the 59th Street Bridge song. Chicago Fed President Evans essentially said the same thing last night as he noted that the lingering effects of the Great Recession remain with us and inflation remains below target.

Separately, if you have never taken the tram to Roosevelt Island it is a great ride across the East River and the views  of the Manhattan during the ride and while on Roosevelt Island are exceptional. The tram parallels the aforementioned 59th Street Bridge as you take the short ride to Roosevelt Island.

Via Bloomberg:
Evans Pushes Go-Slow Tightening Pace as Next Fed Hike Looms
Michael Heath
maheath1
Jeanna Smialek
jeannasmialek
October 10, 2016 — 10:00 PM EDT
Updated on October 11, 2016 — 1:26 AM EDT

Chicago Fed chief says that unemployment can likely go lower
Evans wants to see core inflation moving up in sustained way

The U.S. economy probably isn’t at full employment and inflation remains below-target, Federal Reserve Bank of Chicago President Charles Evans said as he argued for keeping interest rates low until core inflation moves higher.

“Repairing damage incurred from the Great Recession continues to be critical for improving labor force quality for stronger, long-lasting growth,” Evans said, according to a text of his remarks prepared for delivering in Sydney on Tuesday. In this context, “incorrectly inferring that U.S. is at full employment; and prematurely tightening policy would carry particularly high social costs.”

Fed policy makers left their benchmark interest rate unchanged in September for their sixth straight meeting, though the decision came over the objection of three voters on the policy-setting Federal Open Market Committee who favored a hike. Fed Vice Chairman Stanley Fischer on Sunday called it a “close call.”

Evans said policy “may well be changing soon,” repeating an observation he made last week. Minutes of the Sept. 20-21 FOMC meeting will be released on Wednesday in Washington.

Speaking with reporters following the Sydney event, the Chicago Fed chief was asked whether next month’s U.S. election ruled out a rate increase before December.

“One move isn’t that big of a deal either way,” he said. “Even though I would like to wait and gather more information and have more confidence about inflation, I think one move would not seriously affect the continuing likelihood that inflation will move up. In that context, anything related to the election or other developments, I think it’s going to come down to how we view inflation and the progress of the labor market.”

The FOMC next meets in Washington on Nov. 1-2. The central bank started off the year projecting four rate increases but has since reduced its 2016 outlook to one rate hike, which investors and economists mostly expect in December.
Inflation Target

Evans, who does not vote on the policy-setting FOMC this year, argued the Fed ought to wait to see inflation moving closer to its 2 percent goal before raising rates in order to ensure it really achieves the target.

“I would prefer that at the time we make our next move, FOMC communications would also indicate that subsequent increases will be dependent on seeing further positive developments in inflation indicators,” Evans said. “I believe this would help assure the public that the Committee is seeking economic and financial conditions to support inflation attaining our 2 percent target sustainably, symmetrically and sooner rather than later.”

Evans also said that in a world where potential growth has slowed and the neutral rate of interest — the one that neither stimulates nor slows the economy — has moved lower, “we need to rethink our old policy benchmarks with this new calibration in mind.”

In Sydney, reporters again asked Evans about a rate increase at the end of the year.

“A December move could be fine,” Evans said. “It depends on the ultimate strategy of whether or not we think, absolutely, beginning more renormalization is right. Sometimes I think we’d be well served if we were to wait a little bit longer and allow inflation to pick up more quickly.”

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Some Corporate Bond Stuff

Via Bloomberg:

IG CREDIT: 5Y Issues Led Low Volume Friday Session
2016-10-11 10:25:32.849 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $11.2b Friday vs $17.3b Thursday, $15.3b the previous
Friday. 10-DMA $15.8b; 10-Friday moving avg $11.5b.

* 144a trading added $1.9b of IG volume Friday vs $2.2b
Thursday, $2.2b last Friday

* Trace most active issues:
* SANTAN 2.875% 2021 was 1st with client and affiliate
flows accounting for 94% of volume
* WBA 2.60% 2021 was next with dealer-to-dealer trades
taking 65% of volume, client selling 25%
* JPM 1.65% 2019 was 3rd with client and affiliate trades
taking 93% of volume; buying near twice selling
* HPE 2.45% 2017 was the most active 144a issue with client
buying taking 100% of volume

* Bloomberg Barclays US IG Corporate Bond Index OAS at 134, a
new YTD tight, vs 135
* 2016 wide/tight: 215 (a new wide since Jan. 2012)/134
* 2015 wide/tight: 171/122
* 2014 wide/tight: 137/97
* All time wide/tight back to 1989: 555 (Dec. 2008)/54
(March 1997)

* Standard & Poor’s Global Fixed Income Research IG Index at
+184, a new tight for 2016, vs +185
* +262, the new wide going back to 2013, was seen
2/11/2016

* Current market levels vs early Friday:
* 2Y 0.862% vs 0.854%
* 10Y 1.764% vs 1.748%
* Dow futures -33 vs -19
* Oil $50.90 vs $50.63
* ¥en 103.87 vs 103.80

* IG issuance totaled $3b Friday, a totally under the radar
144a 5Y at +300

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FX

Via Marc Chandler at Brown Brothers:

Dollar Remains Bid

• The dollar is bid and an important driver is the backing up of US rates
• Japan reported a larger than expected August trade and current account figures
• Sterling cannot find any traction
• Minneapolis Fed President Kashkari is the only Fed speaker today
• South Africa’s Finance Minister Gordhan has been summoned to appear in court to face charges; South Africa reports August manufacturing production
• Mexico reports September ANTAD retail sales

The dollar is broadly firmer against the majors.  The Loonie and the euro are outperforming, while Kiwi and the Swedish krona are underperforming.  EM currencies are broadly weaker.  MXN, RON, and CNY are outperforming while ZAR, KRW, and RUB are underperforming.  MSCI Asia Pacific was down 0.6%, even as the Nikkei rose 1%.  MSCI EM is down 1.1%, with Chinese markets up 0.4% after returning from a week-long holiday.  Euro Stoxx 600 is down 0.1% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is up 5 bp at 1.77%.  Commodity prices are mostly lower, with oil down 0.5%, copper down 0.4%, and gold down 0.2%.  

The US dollar is bid against all the major and most emerging market currencies.  An important driver is the backing up of US rates.  The two-year yield, which is particularly sensitive to Fed policy is at its highest level since early June (~86 bp).  The US 10-year yield is five basis points higher today at 1.77%, which is the highest in four months.    

In comparison, Europe’s two-year yields are mostly lower today.  Germany’s two-year yield is minus 68 bp and Japan’s stands at minus 27 bp.  The UK two-year yield is below 20 bp.  

Germany’s ZEW survey handily beat expectations, but this has not deterred the euro from being sold back to the pre-US jobs low near $1.1100.  The assessment of the current situation rose to 59.5 from 55.1 in September.   It is the highest since January.  The expectations component rose to 6.2 from 0.5.  The median forecast was for a 4.0.  It is the best reading since June.  A break of the $1.1100 area would target the early-August low near $1.1045.  

Japan reported a larger than expected August trade and current account figures.  The dollar’s rally that began on September 22 has seen only two losing sessions:  September 26 and October 7.  The dollar recovered its post-job data losses yesterday and returned briefly poked through JPY104 earlier today.  Last week’s high was recorded near JPY104.15 and last month’s high was closer to JPY104.35.  

Japan’s August current account surplus was a JPY2 trillion.  The median guesstimate was JPY1.5 trillion after JPY1.94 trillion in September.  This represents a nearly 25% increase from a year ago. The trade surplus was reduced as it typically is in August from July.  However, it was more than twice as big as expected at JPY243 bln.  

 Sterling cannot find any traction.  It is extending its losses against the dollar for the fourth consecutive session.  It has fallen in eight of the past 10 sessions.  The euro has risen against sterling for four consecutive sessions also and in nine of the past 10 sessions.  The general direction has been set in motion, not by UK economic data, which continues to surprise on the upside, but by fears that the UK will cut its nose to spite its face.  The newest wrinkle is a potential constitutional challenge as Parliament is insisting that it play a larger role in the Brexit decision than Prime Minister May is prepared to concede.  

A hard exit is thought to be more negative for sterling for a number of reasons, including a greater burden on prices (weaker sterling, higher domestic inflation to adjust the external deficit rather than volume (trade and capital flows).  That said, the selling pressure appears to have abated as the London morning got under way.  Upticks from $1.2280 may extend toward $1.2330-$1.2350.  Note that the low since the flash-crash low was near $1.2230.

US political developments and news that Russia may cooperate with OPEC producers to stabilize the market sent the Canadian dollar sharply higher Monday.  Canadian markets were closed yesterday, and it was a partial holiday in the US.  The US dollar fell nearly 1% against the Canadian dollar; its biggest drop since late-July.  Oil prices are consolidating yesterday’s advance, while the US dollar climbed from CAD1.3140 yesterday to almost CAD1.3235 today.  Initial support is seen near CAD1.3180.  

The Federal Reserve’s new Labor Market Conditions Index is the main economic report today.   The highlight of the week is the retail sales report on Friday.  After taking August off, consumers went shopping again in September.  The FOMC minutes from the September meeting will be reported tomorrow.  Canada reports housing starts today and existing home sales at the end of the week.  

Minneapolis Fed President Kashkari is the only Fed speaker today.  He appears to lean toward the dovish size of the spectrum at the Fed, but with Chicago Fed’s Evans, a notable dove, acknowledging a rate hike is likely this year, what it means to be a dove may be changing.  Also as we have noted before, Kashkari favors breaking up the banks to address the too-big-to-fail concerns as opposed to the current approach of increased regulation (limits on activity and higher capital requirements).

South Africa’s Finance Minister Gordhan has been summoned to appear in court to face charges.  This matter had died down but continued to simmer.  It has now boiled over.  Reports suggest Gordhan will be charged with committing fraud when he was heading up the tax authority, but most see it as a politically motivated by President Zuma.  Investors have been buying the rand in recent weeks, ignoring political risk at their own peril.  We think these developments will cement a downgrade to sub-investment grade, and keep downward pressure on the rand.

South Africa reports August manufacturing production, which is expected to rise 1.3% y/y vs. 0.4% in July.  The economy remains weak, while inflation is finally turning lower.  SARB next meets November 24.  A lot can happen between now and then, but we think the major factor will be the exchange rate.  SARB is reluctant to hike rates further, but a weaker rand would lead to inflation pass-through and may not allow the bank to remain on hold.  

Mexico reports September ANTAD retail sales, which is expected to rise 5.2% y/y vs. 1.7% in August.  Despite what we see as nebulous links between Trump and the peso, the currency did firm nearly 2% on Monday after a damaging video was released late Friday.  This was followed on Sunday by what many perceived as another poor debate showing for the Republican candidate.  The next Banco de Mexico policy meeting is November 17, and much will depend on how the peso is trading.  Our base case is steady Mexico rates in November, followed by a hike to match the US if the Fed hikes in December.

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Credit Pipeline

Via Bloomberg:

IG CREDIT PIPELINE: 2 to Price; Saudi Roadshows to Begin
2016-10-11 09:55:46.184 GMT

By Robert Elson
(Bloomberg) — Expected to price today:

* KEB Hana Bank (KEB) A1/A; to price $benchmark 144a/Reg-S 2-
part deal, via managers C/CA/JPM/SCB/UBS
* 3Y, IPT +95 area
* 5Y, IPT +105 area
* Sumitomo Mitsui Financial Group (SMFG) A1/A-, to price 2-
part deal, via BAML/C/GS/SMBC Nik
* 5Y FRN, IPT equiv
* 5y, ipt +135-140
* Sumitomo Mitsui Banking Group (SMBC) A1/A, to price 2-part
deal, via GS/SMBC
* 2Y FRN, IPT equiv
* 2Y, IPT +110 area

LATEST UPDATES:

* Kingdom of Saudi Arabia (SAUDI), to hold investor meetings
Oct. 12-18, via C/HSBC/JPM along with BoC/BNP/DB/GS/MS/MUFG;
144a/Reg-S 5Y/10Y/30Y deal expected to follow
* Sirius International Group (SIRINT) na/BBB/BBB-, has
manadated AMTD/BoC/C/JPM/WFS for 144a/Reg-S USD bond; last
issued in 2007
* Honeywell (HON) A2/A,announced a possible 4Q debt
refinancing in its guidance release Oct. 6
* May consider refinancing 2018, 2021 bonds, BI says
* Darden Restaurants (DRI) Baa3/BBB, filed debt shelf, last
seen in 2012
* Darden announced a new $500m share buyback program in
its 1Q earnings release
* Yes Bank (YESIN) Baa3/na, plans to raise $500m by year’s end
* Republic of Namibia (REPNAM) Baa3/BBB-, to hold non-deal
investor meetings Oct. 7-13, via Barc/JPM/StanBk
* Japan International Cooperation Agency (JICA) na/A+, files
to sell $125m bonds, via Barc/BAML/Daiwa
* ICBC NY Branch (ICBCAS) A1/A, hires BNP/BAML/C/WFS for
investor meetings Oct. 11-14; USD $benchmark issue expected
to follow
* Asciano (AIOAU) Baa3/BBB-, names ANZ/BNP/Miz for investor
meetings Oct. 10-28; it is a non-deal roadshow; last priced
a USD deal in 2011
* Western Union (WU) Baa2/BBB, filed debt shelf; last issued
Nov. 2013 following Oct. 2013 filing
* Export-Import Bank of Korea (EIBKOR) Aa2/AA, hires
ANZ/BAML/CA/Miz/Samsung/SG/UBS for investor meetings from
Oct. 3; USD short to intermediate maturity deal may follow
* Comision Federal De Electricidad (CFELEC) Baa1/BBB+,
mandates BBVA/BAML/C for investor meetings from Oct. 4
* Global Bank Corp (GLBACO) Ba1/BBB-/BBB-, has mandated
C/DB/JPM/UBS for investor meetings Oct. 3-6; 144a/Reg-S
$benchmark deal is expected to follow
* Government of Bermuda (BERMUD) A2/A+, mandates HSBC for
roadshows Sept. 30- Oct. 10; 144a/Reg-S issue expected to
follow
* Partial tender also announced
* Bermuda last priced a USD deal in 2013
* Nafin (NAFIN) A3/BBB+; mandates BofAML, HSBC for investor
meetings Sept. 27-28; USD-denominated deal may follow
* Analog Devices (ADI) A3/BBB; ~$13.1b Linear Technology acq
* $5b loan received after $11.6b bridge (Sept. 26)
* Sumitomo Mitsui Trust Bank (SUMIBK) A1/A; mandates
C/Daiwa/GS/JPM to arrange investor calls beginning Sept. 26;
144a/Reg-S 3Y fixed and/or floating issue expected to price
in the near future

MANDATES/MEETINGS

* HollyFrontier (HFC) Baa3/BBB-; investor calls Sept. 15-16
* Banco Inbursa (BINBUR) –/BBB+/BBB+; mtgs Sept. 7-12
* Woolworths (WOWAU) Baa2/BBB; investor call Sept. 7
* Sydney Airport (SYDAU) Baa2/BBB; investor calls Sept. 6-7
* Korea National Oil (KOROIL) Aa2/AA; meetings from Sept. 6
* Industrial Bank of Korea (INDKOR) Aa2/AA-; mtgs from Aug. 22
* Sumitomo Life (SUMILF) A3/BBB+; investor mtg July 19

M&A-RELATED

* Bayer (BAYNGR) A3/A-; ~$66b Monsanto acq
* Hybrid bond sales planned; part of $57b bridge (Sept.
14)
* Danaher (DHR) A2/A; ~$4b Cepheid acq
* Sees financing deal via cash, debt issuance (Sept. 6)
* Couche-Tard (ATDBCN) Baa2/BBB; ~$4.4b CST Brands acq
* Expects to sell USD bonds (Aug. 22)
* Pfizer (PFE) A1/AA; ~$14b Medivation acq;
* Expects to finance deal with existing cash (Aug. 22)
* Danone (BNFP) Baa1/BBB+; ~$12.1b WhiteWave (WWAV) Ba2/BB
* Co. Says deal 100% debt-financed, expects to keep IG
profile (July 7)
* Zimmer Biomet (ZBH) Baa3/BBB; ~$1b LDR acq
* Plans $750m issuance post-completion (June 7)
* Great Plains Energy (GXP) Baa2/BBB+; ~$12.1b Westar acq
* $8b committed debt secured for deal (May 31)
* Abbott (ABT) A2/A+; ~$5.7b St. Jude buy, ~$3.1b Alere buy
* $17.2b bridge loan commitment (April 28)
* Sherwin-Williams (SHW) A2/A; ~$9.3b Valspar buy
* $8.3b debt financing expected (March 20)

SHELF FILINGS

* Starbucks (SBUX) A2/A-; debt shelf; has $400m maturing Dec.
5 (Sept. 15)
* Brunswick (BC) Baa3/BBB-; automatic mixed shelf; last issued
in 2013 (Sept. 6)
* Enbridge (ENBCN) Baa2/BBB+; $7b mixed shelf (Aug. 22)
* IBM (IBM) Aa3/AA-; automatic mixed shelf (July 26)
* Nike (NKE) A1/AA-; automatic debt shelf (July 21)
* Potash Corp (POT) A3/BBB+; debt shelf; last issued March
2015 (June 29)
* Tesla Motors (TSLA); automatic debt, common stk shelf (May
18)
* Reynolds American (RAI) Baa3/BBB; automatic debt shelf; sold
$9b last June (May 13)
* Statoil (STLNO) Aa3/A+; debt shelf; last issued USD Nov.
2014 (May 9)
* Corporate Office (OFC) Baa3/BBB-; debt shelf (April 12)

OTHER

* GE (GE) A1/AA-; Ratings cut by S&P on assumption of
increased debt for next couple of yrs on possible
acquisitions (Sept. 23)
* Israel Electric (ISRELE) Baa2/BBB-; said to hire C, JPM for
at least $500m bond sale in 4Q (Aug. 8)
* Visa (V) A1/A+; CFO says will issue $2b debt for buybacks by
yr end (July 21)
* Investment Corp of Dubai (INVCOR); weighs bond sale (July 4)
* Alcoa (AA) Ba1/BBB-; upstream entity to borrow $1b (June 29)
* Discovery Communications (DISCA) Baa3/BBB-; may revisit bond
market this yr, BI says (May 18)
* American Express (AXP) A3/BBB+; plans ~$3b-$7b term debt
issuance (April)

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Fear Morphs into Greed

Via WSJ:

Markets Streetwise

The Great Market Switcheroo of 2016
y
By James Mackintosh
Updated Oct. 10, 2016 11:30 a.m. ET
4 COMMENTS

Investors who got just one trade right this year would have done brilliantly: Sell everything that did well in the first half of the year and buy everything that did badly.

The reversal has been spread across almost all assets, with leaders becoming laggards and laggards leaders.

Wall Street cynics will be tempted to see this as mere market noise, profit taking by casino capitalists who get bored of one trade and move on to something new. But for those trying to make money, the market’s about-turn contains both a signal, and a deeper message.

The signal is the switch from fear back toward greed. Consider the S&P 500’s best performer in the first six months, Colorado-based gold producer Newmont Mining Corp. It did well as the gold it digs up soared in price alongside bonds (bond prices rise as yields fall). Since the end of June investors have grown greedy again and are less keen to stash their cash in zero-yielding gold, or in dull-but-overpriced bonds. Newmont ranks 480th in the S&P in the second half of the year so far.

The evaporation of fear propelled investors into riskier stocks they shunned earlier in the year. Seagate Technology PLC is at the top of the S&P leader board since the end of June as cheap shares came back into fashion, having been almost the worst in the index in the first six months.

The deeper message is about the stories that drive markets. The demand for safety this year led to an extraordinary bond rally, pushing yields down to silly levels across developed countries. Aggressive central bank action in Japan and Europe combined with worries about the U.S. economy, and the low bond yields had knock-on effects on almost every other asset class as investors scouted out alternatives. But the story changed on July 8, when better-than-expected jobs figures in the U.S. offered relief. Many investors were well outside their comfort zone, holding overpriced defensive stocks or bonds with zero or negative yields that only made sense if the world was going to the dogs.

The jobs figures were better than economists had forecast, but beat the consensus estimate by less than the Bureau of Labor Statistics’ 100,000 margin of error. There were bigger beats in October last year and the year before. However, the figures released in July were special. Investors holding assets they fretted were overpriced were hypersensitive to anything that undermined the dominant story of economic weakness.

The switch back to greed had deep implications, far beyond Newmont and Seagate. Almost everything reversed. Only three of the 10 best performers in the first half even made it into the top half of the index since, while all but three of the worst performers in the first half are in the top 200 since then.

The reverse is most obvious at the sector level, where the spillovers from the bond market stand out. In the first half the S&P 500 was led up by utilities and telecoms, both seen as bond proxies, while IT and financials were by far the two worst performers. Since the end of June the U-turn has been exact, with telecoms and utilities at the bottom and IT and financials winning, by a lot.

It applies internationally, too. With the exception of permanent laggard Italy, the stock markets of the G7 swapped places at the end of June. Stripping out currency effects, Canada, the U.S. and U.K. turned from the best three to the worst, while Germany, France and Japan turned from worst to best. The same is true across major asset classes. Japan had by far the most profitable government bonds to own in the first half, and by far the worst since. Gold was among the best things to own from January to June, and has been horrible since then.

There are exceptions. Emerging markets produced excellent returns in both periods, helped by the parallel story of China stimulus; the energy sector also continued its strong recovery, moving with oil rather than bonds.

Investors need to monitor the stories being told to explain market moves. They also need to pay close attention to the fear and greed of their fellow investors. The more extreme the emotions are, the more sensitive the market will be to news that damages the story.

Surveys suggest that sentiment is currently close to neutral, helping to explain why a disappointing jobs report on Friday had little effect on the market. The dominant story is of moderately rising inflation, a rate increase by the U.S. Federal Reserve most likely in December and slow but steady growth. It will be upset at some point, but for now at least the market isn’t hypersensitive to bad news.

Write to James Mackintosh at [email protected]

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German ZEW Surges

Via Bloomberg:
German ZEW Investor Sentiment Jumps in Sign Economy Robust
Piotr Skolimowski
Skolimowski
October 11, 2016 — 5:09 AM EDT
Updated on October 11, 2016 — 5:33 AM EDT

Gauge for expectations rises to 6.2 in Oct. from 0.5 in Sept.
ZEW says German banks currently are burden to economic outlook

German investor confidence improved more than economists anticipated in October in a sign that growth remains robust even as concerns about German banks weigh on the outlook, according to the ZEW Center for European Economic Research in Mannheim.
Key Points

Index of investor and analyst expectations, which aims to predict economic developments six months ahead, rose to 6.2 from 0.5 in September
Reading is highest since June; median forecast was for increase to 4
Index of current situations rose to 59.5 from 55.1

Big Picture

The report comes after a string of bumper results from the German economy, with August exports surging the most since 2010 and factory orders growing at the fastest pace in five months. Business sentiment jumped to the highest level in more than two years in September. Even so, the Bundesbank has toned down its outlook, pointing to slower growth in the third quarter, as concerns remain over the consequences of Britain’s decision to leave the European Union. Uncertainty related to prospects of a multi-billion-dollar penalty for Deutsche Bank AG in the U.S. are also adding to risks.
Economist Takeaways

The positive reading is “broadly encouraging, although the index still points to a slowdown in German GDP growth,” said Jennifer McKeown, senior European economist at Capital Economics in London. The gauge “is now at its highest level in four months, suggesting that easing fears about the effects of Brexit have more than offset concerns about the wider implications of Deutsche Bank’s troubles.”
Other Details

Improved economic sentiment is sign of “relatively robust economic activity,” ZEW President Achim Wambach said in a statement
Wambach said positive impulses from industry, exports shouldn’t distract from economic, political risks; banks are currently a burden to outlook
ZEW measure for expectations in the euro area climbed to 12.3 from 5.4

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