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A decent start to the week

One eye on the Fed Stock markets are off to a decent start at the beginning of the week, one that will be heavily focused on US economic data ahead of…

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One eye on the Fed

Stock markets are off to a decent start at the beginning of the week, one that will be heavily focused on US economic data ahead of the September Fed meeting.

In many ways, it feels a little early for there to be so much attention on the meeting next week and yet, it very much seems that is what is happening. The jobs report a couple of weeks ago threw a massive spanner in the works as far as tapering is concerned but the message coming from policymakers suggests they remain undeterred.

Now that we’re into the blackout period, we’ll have to rely on the data to form our opinions on what the Fed will decide next week and in the final months of the year, starting with the inflation readings on Tuesday.

Any indication that inflation is not as transitory as the central bank currently believes could pile on the pressure to remove stimulus more aggressively and cause some distress in the markets, something investors are very sensitive to.

Central banks are being extremely cautious though and are keen to point out that the removal of emergency stimulus measures is not linked to future rate hikes.

The ECB took its foot slightly off the gas last week in what was viewed as a first step towards removing stimulus. It was a cautious first move but perhaps a sign that policymakers are wary about higher inflation.

Bitcoin testing major support

Bitcoin is coming under pressure once more on Monday, a little under a week after it plunged 17% following its debut in El Salvador.

Once again, the cryptocurrency finds itself close to $44,000 where it has previously found strong support. A significant break of this level could be bad news for bitcoin in the near term.

For weeks now, it has been showing signs of topping out, with rallies lacking momentum and the lows being repeatedly tested. A break of $50,000 may have improved its fortunes, alongside it being adopted as legal tender in El Salvador – a massive experiment for the country and bitcoin – but instead, it quickly crashed and it’s struggling to find its feet.

You can’t write off bitcoin, not when there’s so much excitement in the space, but a break below $44,000 could be troublesome. Even another 20% would leave it well above the lows it reached earlier this summer so we shouldn’t get too carried away. Maybe Elon Musk will ride to the rescue again.

Economics

Goldman Raises Year-End Oil Price Target To $90

Goldman Raises Year-End Oil Price Target To $90

Just days after Goldman’s head commodity analyst Jeff Currie told Bloomberg TV that the bank…

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Goldman Raises Year-End Oil Price Target To $90

Just days after Goldman's head commodity analyst Jeff Currie told Bloomberg TV that the bank anticipates oil spiking to $90 if the winter is colder than usual, on Sunday afternoon Goldman went ahead and made that its base case and in a note from energy strategist Damien Courvalin, he writes that with Brent prices reaching new highs since October 2018, the bank now forecasts that this rally will continue, "with our year-end Brent forecast of $90/bbl vs. $80/bbl previously."

What tipped the scales is that while Goldman has long held a bullish oil view, "the current global oil supply-demand deficit is larger than we expected, with the recovery in global demand from the Delta impact even faster than our above consensus forecast and with global supply remaining short of our below consensus forecasts."

Among the supply factors cited by Goldman is hurricane Ida - the "most bullish hurricane in US history" - which more than offset the ramp-up in OPEC+ production since July with non-OPEC+ non-shale production continuing to disappoint.

Meanwhile, as noted above, on the demand side Goldman cited low hospitalization rates which are leading more countries to re-open, including to international travel in particularly COVID-averse countries in Asia.

Finally, from a seasonal standpoint, Courvalin sees winter demand risks as "further now squarely skewed to the upside" as the global gas shortage will increase oil fired power generation.

From a fundamental standpoint, the current c.4.5 mb/d observable inventory draws are the largest on record, including for global SPRs and oil on water, and follow the longest deficit on record, started in June 2020.

For the oil bears, Goldman does not see this deficit as reversing in coming months as its scale will overwhelm both the willingness and ability for OPEC+ to ramp up, with the shale supply response just starting.

This sets the stage for inventories to fall to their lowest level since 2013 by year-end (after adjusting for pipeline fill), supporting further backwardation in the oil forward curve where positioning remains low.

But what about a production response? While Goldman does expect short-cycle production to respond by 2022 at the bank's higher price forecast, from core-OPEC, Russia and shale, this according to Goldman, will only lay bare the structural nature of the oil market repricing. To be sure, there will likely be a time to be tactically bearish in 2022, especially if a US-Iran deal is eventually reached. The bank's base-case assumption is for such an agreement to be reached in April, leading the bank to then trim its price target to an $80/bbl price forecast in 2Q22-4Q22 (vs. its 4Q21-1Q22 $85/bbl quarterly average forecast). This would, however, remain a tactical call and a likely timespread trade according to Courvalin, with long-dated oil prices poised to reset higher from current levels, especially as the hedging momentum shifts from US producer selling to airline buying (a move which Goldman says to position for with a long Dec-22 Brent and short Dec-22 Brent put trade recommendations).

 

Meanwhile, the lack of long-cycle capex response - here you can thank the green crazy sweeping the world - the quickly diminishing OPEC spare capacity (Goldman expects normalization by early 2022), the inability for shale producers to sustain production growth (given their low reinvestment rate targets) and oil service and carbon cost inflation will all instead point to the need for sustainably higher long-dated oil prices. Remarkably, Goldman now expects the market to return to a structural deficit by 2H23, which leads it to raise its 2023 oil price forecast from $65/bbl to $85/bbl, and the mid-cycle valuation oil price used by Goldman's equity analysts to $70/bbl.

Translation: expect a slew of price hikes on energy stocks in the coming days from Goldman.

Finally, where could Goldman's forecast - which would infuriate the white house as gasoline prices are about to explode higher - be wrong? For what it's worth, the bank sees the greatest risk on the timeline of its bullish view. On the demand side, it would take a potentially new variant that renders vaccine ineffective. Beyond that, however, the bank expects limited downside risk from China, with its economists not expecting a hard landing and with our demand growth forecast driven by DMs and other EMs instead. This leaves near-term risks having to come from the supply side, most notably OPEC+, which next meets on October 4. And while an aggressively faster ramp-up in production by year-end would soften (but not derail) our projected deficit, it would only further delay the shale rebound, which would reinforce the structural nature of the next rally given binding under-investment in oil services by 2023. In addition, a large ramp-up in OPEC+ production would simply fast-forward the decline in global spare capacity to historically low levels, replacing a cyclical tight market with a structural one.

The full report as usual available to pro subscribers in the usual place.

Tyler Durden Sun, 09/26/2021 - 20:36
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Economics

Weekly Market Pulse: Not So Evergrande

US stocks sold off last Monday due to fears over the potential – likely – failure of China Evergrande, a real estate developer that has suddenly discovered…

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US stocks sold off last Monday due to fears over the potential – likely – failure of China Evergrande, a real estate developer that has suddenly discovered the perils of leverage. Well that and the perils of being in an industry not currently favored by Xi Jinping. He has declared that houses are for living in not speculating on and ordered the state controlled banks to lend accordingly. Evergrande is known as a real estate developer and it certainly is but it is also a sprawling company with investments in multiple industries including, of course, an electric car company. Cutting off its financing isn’t just going to affect the Chinese real estate market. And real estate accounts for roughly 70% of household net worth in China so everyone in the country is going to take a hit. But is there a connection to the US or other developed country stock markets?

Real estate represents anywhere from 15 to 25% of the Chinese economy depending on what source you want to believe. The exact number isn’t really important, just suffice it to say that construction is a very large part of China’s economy and speculating on real estate is a national pastime. But the impact of it goes well beyond China. It is well known – according to the news reports I read – that China’s share of global commodity consumption is large and a large part of that goes to the construction industry. I read some research last week that claimed China’s property sector accounted for 20% of global steel and copper output. That sure sounds big and scary – as I’m sure the authors intended – but I would just point out that copper prices are near their all time highs and actually finished higher last week. The general commodity indexes were higher too. If Evergrande’s demise is going to materially impact commodity demand you wouldn’t know it from last week’s action. Maybe China’s commodity consumption isn’t “well known” in the commodity pits.

The doom and gloom crowd spent all of last week trying to convince investors – or themselves – that Evergrande is China’s “Lehman moment”, based on nothing more than the fact that Evergrande and Lehman both involved real estate. And in the case of Lehman that connection was incidental but superficially I guess the comparison made sense. There are certainly banks with exposure to Evergrande but the vast majority of them are Chinese. HSBC has been mentioned as having exposure but they stopped lending on Evergrande properties a few months ago. UBS was said to have exposure but the CEO said last week it was immaterial. Credit Suisse, which seems to be the new Citibank, involved in just about everything that has blown up the last few years, was so happy they avoided this one they almost broke an arm patting themselves on the back. US banks, as best I can tell, have no exposure. There are some junk bond funds with exposure but for the ones I looked at, it was a rounding error. There just doesn’t seem to be much interconnection with the rest of the global financial system and that was reflected in credit default swaps and credit spreads which barely moved on the week. 

Evergrande appears to be mostly a domestic China concern, at least for now. The impact will be seen in Chinese growth figures which were already on the decline. What does that mean for the rest of the world? I don’t know yet but I am old enough to remember the last time the world’s second largest economy popped a real estate bubble. That was Japan in the early 90s and their economy certainly suffered over the next decade but you’d be hard pressed to find a big blowback on the rest of the global economy. Maybe China will be different but I can easily make a case that a Chinese economic slowdown would be beneficial to the rest of the world. Suppose those estimates of commodity consumption are correct and copper and steel prices take a tumble. That probably wouldn’t be pleasant for Chile and Brazil (iron ore) but I’d guess that the rest of the world would welcome cheaper steel and copper. There are plenty of things to worry about right here in the US with political wrangling over the debt ceiling, a possible government shutdown (which I generally take as a positive) and potential tax and spending hikes. I see no need – yet – to start worrying about Xi Jinping’s re-Maoing of the Chinese economy.

For stock investors I think the more important event last week was the rapid rise of the 10 year Treasury yield from Wednesday to Friday. I don’t mean to imply that higher rates mean stocks are going to fall because history says that isn’t the likely outcome. Rising rates are generally associated with rising growth expectations which doesn’t exactly strike fear into stock investor’s hearts. And that is what we saw last week as inflation expectations were unchanged as real rate rose exactly the same as nominal rates. Higher rates will affect which stocks perform well though and we started to see that last week. Higher rates and a steeper yield curve were positive for financials. Energy stocks also had a very good week. In general, I’d expect value stocks to perform better if rates keep rising while growth stocks take a breather.

The move in rates last week came with seemingly no trigger. There was no economic data or other event that should have changed growth expectations. Of course, there really wasn’t any spur for the bond rally of the last 6 months either. But eventually the data caught up with the market and it probably will again. I say probably because markets are not always right, just most of the time. What I think we’re going to see over the next few weeks is the market anticipating the end of the Delta surge and the resumption of the economic re-opening both here and in Europe. Whether it does or not or how long it might last or how far it might go I don’t know. But that investors will try to front run the virus isn’t exactly news. Of course people will try to get ahead of events. 

During the course of an  economic cycle, growth will ebb and flow. We’ve just come through a growth rate slowdown and bond yields now seem to be anticipating a growth rate upturn. I’m not convinced yet and there’s a lot of potential potholes ahead – mostly political – so I’ll continue to classify the environment as slowing growth/strong dollar but that may not last long. One thing I still don’t see is any change in the dollar trend. It is a short term uptrend and I’ve acknowledge that but the long term trend is no trend at all. The dollar index is in the bottom half of the range it’s been in for over 6 years and I don’t know what would change that. The lack of a dollar trend makes our job a bit more difficult and shorter term but we play the hand we’re dealt. 


 

The economic data last week was a little better and better than expected but not significantly so. Housing starts improved as have sales over the last quarter but still well below last year’s peak. Existing home sales are still softening and we’re starting to see some price cuts which is the only thing that is going to have a big impact on sales.

The monthly reading of the CFNAI fell back a bit but the 3 month average moved higher to 0.43, a reading that indicates the economy continues to grow above trend. We had a slowdown but it didn’t amount to much.

 

 

 

This week’s data includes durable goods, personal income and consumption, the Chicago PMI and the ISM manufacturing index. I think the two to keep an eye on are income and consumption. It will be interesting to see if either was impacted by the impending end of extended unemployment benefits.

 

Commodities had a good week which seems curious considering the potential growth impact of Evergrande. But as the title says, maybe it isn’t so Grande. Maybe it is just pequeno. 

US and European stocks were up last week while the rest of the world was down. Is that because a China slowdown is good for the US and Europe and bad for Asia and Emerging markets more generally? Maybe but I think I’ll wait for more evidence on that front before making any big pronouncements.

Value outperformed last week across all market caps.

 

As I said above financials and energy led last week. Of equal importance I think is that real estate and utilities – both rate sensitive – lagged the field. If rates keep rising, that seems likely to continue as well. 

 

The 10 year Treasury yield bottomed in March 2020 around 40 basis points. It rose and then fell back to about 50 basis points in August of last year. It rose too far, too fast (1.75%) and the last six months has been nothing but a correction of that trend. Now, it appears rates are resuming their rise. How far will they go? Assuming the Delta end/re-re-opening narrative takes hold and there are no surprises along the way – some very large assumptions – my inner trader says about 1.85% as a first target. But that’s just an extrapolation so I wouldn’t place any big bets on it. What most investors should know is that rates are in an uptrend because the economy continues to recover from COVID. We had a growth rate slowdown and so far that’s all it was. And the market says it is ending. I’ll take that over all the breathless Evergrande articles any day.

Joe Calhoun

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Economics

As Margins Begin To Slide, Will Corporations Choose To Defend Profits Or Absorb Transitory Shocks

As Margins Begin To Slide, Will Corporations Choose To Defend Profits Or Absorb Transitory Shocks

Having spent much of the summer warning…

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As Margins Begin To Slide, Will Corporations Choose To Defend Profits Or Absorb Transitory Shocks

Having spent much of the summer warning that as a result of surging labor costs, commodity prices and generally "transitory hyperinflation", corporate margins would tumble (which in the view of Morgan Stanley would lead to a 10% correction), three weeks ago we warned that we are about to see a surge in profit warnings as the realization that the current unprecedented ascent in prices is going to be anything but transitory.

Sure enough, shortly after we noted that "Profit Warnings Are Coming Fast And Furious As Q3 Profits Brace For Big Hit" it wasn't until Nike and FedEx's dismal outlooks that the world finally paid attention to the coming stagflationary wave.

As we reported last week, Fedex tumbled after it reported that not only did it miss Q1 earnings - just hours after announcing it was raising prices at the fastest pace in decades - but also slashed guidance, warning about sharply higher labor costs and operating expenses.Picking up on this, earlier today Nordea also chimed in saying that "FedEx adjusted down expectations and cited being 35% understaffed in various parts of the supply chain as an important reason why. This is not good!" Yes... after the fact.

We won't waste our readers' time on why margins are set to plunge, and drag profits along with them absent a continued surge in revenues - we have discussed that extensively in the past few months - but we will highlight a recent note from SocGen's Andrew Lapthorne who cuts through the noise and says that corporates now have to make a decision: defend high margins or absorb "transitory" shocks.

As Lapthorne writes last week, while the rest of the world's attention turns to China, his charts focused on corporate profitability given the concerns about rising costs, supply disruption and now higher energy costs. According to the SocGen strategist, reported EBIT growth in the US has jumped by over 30% and over 55% in Europe, a remarkable surge which has been accompanied by a sharp increase in profit margins as sales growth has easily outstripped the growth in costs. Indeed, as noted recently, US profit margins hit an all all-time high in Q2, leading to a substantial uplift in profit margins to all-time highs.

Why the focus on margins and profitability? As Lapthorne explains, "profit margins act as shock absorbers. If businesses can absorb price shocks and business disruption into their P&L instead of passing the problems onto customers then logic has it that short-term profitability would be hit, but bigger issues, such as the need for policy tightening, is reduced."

And while on aggregate profit margins are healthy enough - for now - to absorb some temporary pain, it will be interesting to see what path the corporates take: to defend margins and risk inflation taking hold, or allow profits suffer for a while?

Tyler Durden Sun, 09/26/2021 - 17:30
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