 The Market Sum | Insight after the bell
By James Early Tuesday's Headlines 1. U.S. Markets Retreat After Four Days of Gains 2. Volcker Rule May Get Less Volcker-ish 3. Coming to America: Zero Interest Rates? 4. Household Debt Hits All-Time High Markets Closed
 Markets Today
With no major economic news today, investors were left to spin on their inner feelings, and those feelings were a touch dour. The S&P 500 dropped nearly eight-tenths of a point, with the Nasdaq and Dow down 0.65% and 0.68%, respectively. And in typical risk-off fashion, U.S. Treasury yields fell (because prices rose) as those dour minds favored safety a bit more.
In an era where it seems hard for a global central banker to say something that's not negative, investors are awaiting the tenor that comes out of the U.S. Federal Reserve's Jackson Hole meeting later this week. The probability of a rate cut at the Fed's September meeting was 95% as of this morning, according to the CME Group's FedWatch Tool, so the focus is likely more on the Fed's messaging than its mechanics.
Worth mentioning is that not everyone is on board with the mechanics. Boston Fed Chair Eric Rosengren, who dissented from July's rate cut, says we need more evidence of a U.S. economic slowdown to justify cutting more. After all, unemployment is at a 50-year low, July retail sales were the best in four months, and inflation was at 1.8% most recently, quite close to the Fed's 2% target. Nobel Prize-winning economist Robert Schiller is in the same boat, declaring that the negative signaling effects of July's rate cute—rate cuts are a sign to the world that a central bank sees a troubled economy—outweighed the strict economic benefits. The anti-cut camp has two main worries: First, that by cutting rates when cutting is not fully necessary, the Fed gives up precious ammo that it may need later. Second, that the debt (especially variable-rate debt) that borrowers obediently load up on following rate cuts could turn into a headwind in a recession that brings rising interest rates and rising unemployment. Yes, there's a logic to it. But a rate cut seems likely to happen no matter what these guys think.
Home Depot Glass-half-full Home Depot shareholders have had a good 2019, and got roughly 4.5% richer today. The market decided to forgive both missed sales expectations ($30.84 billion for the quarter vs. $30.99 expected, and same-store sales growth of 3% vs. 3.5% expected) and trade-war-lowered sales guidance, instead focusing on how nicely the $3.17 in per-share earnings exceeded the $3.08 projected.
Kohl's Kohl's investors saw their glass as half-empty, pushing the stock down nearly 7% on—guess what?—a positive earnings surprise and a revenue miss. For better or for worse, Kohl's investors are at least willing to change their minds: the stock was initially up 6.3% in pre-market trading. But Kohl's has seen same-store sales shrink lately (2.9% recently vs. 2.4% expected), so the earnings surprise of $1.55 per share (vs. $1.53 expected) wasn't, upon further reflection, enough to cheer this crowd up.   Making Proprietary Trading a Little More Proprietary Clarification and easing of the Volcker Rule restricting banks from proprietary trading doesn't seem like a big deal—unless you're a bank, in which case you've been sifting through literally 21 different sets of frequently asked questions just to figure out how it applies. The Volcker Rule was not undone today—that would require Congress' approval—but the FDIC proposed a clarifying methodology that should give banks a little more leeway in their proprietary trading, which has been tightly restricted following the 2008 financial crisis.
What's so evil about proprietary trading? Well, it's not evil, but one of the causes of the 2008 financial crisis was banks—then regulated under looser commercial banking standards—taking (arguably) more risk than they were regulated for. Enter 6'7" Paul Volcker, former Federal Reserve chair from nearly 40 years ago. The Volcker Rule, as part of the Dodd-Frank post-financial crisis regulatory package, put the brakes on proprietary trading, but banks long felt his measures were a little strict.
This isn't the first time Volcker has come under fire for being a disciplinarian. As Fed Chairman in 1979, Volcker was tasked with taming massive inflation—roughly 15% annually. Tame it he did, by raising the federal funds rate to an astronomic 19%. Not long later, inflation had cooled to 5%, but the U.S. endured a short recession in 1980 and then a longer one from 1981–1982 (the "Volcker Recession"), as well as a near-11% unemployment rate. Critics say Volcker was too severe. Proponents say that by forcing the U.S. to take the pain upfront, he averted an even worse future.  Zero Interest Rates Coming to a Bank Near You? If you live in the U.S., outspoken fund manager Kyle Bass seems to think so. Bass notes that with $15 trillion in global debt already trading at negative yields, and most major economies' central banks setting rates in the low—emphasis on "low"— single digits, the U.S. is a relative last man standing with comparatively higher rates. And Bass thinks it may not be standing for long.
The scary truth is that nobody knows quite what would happen if U.S. yields were to go negative. Complete unknowns tend to be bad in the world of finance. As Bass points out, the U.S. has 90% of the world's investment grade debt (technically 94% now, according to Bank of America). It's one thing to notice Danish housing prices rising now that Danes are getting paid to borrow money to buy houses, although that's still a head-spinner to me. But for the world's largest economy? Nobody knows.
One important fact: According to Bank of America, the average sovereign yield outside the U.S. is now negative. Wow. And considering that, if you're a foreign investor looking to buy bonds with at least a little yield, where do you think you might go?
That's right. And, some analysts say, foreign investor demand pushing U.S. interest rates lower can be found in the yield curve. As we know, markets went haywire last week when 10-year Treasury bond rates dipped below 2-year rates—an occurrence that preceded seven out of the last seven U.S. recessions. The standard explanation is American investors' fear: Spooked pockets seek the long end of the curve for safety. But this time may actually be a little bit different: Instead of spooked Americans, it may be foreign investors jaded by lowball rates elsewhere who are piling into long-dated Treasuries. If this is true, it could mean Bass' zero-rate days are a small step closer, but also that the recent yield curve inversion (which quickly corrected itself, incidentally) is less a predictor of doom and gloom and more a mathematical artifact of outside investors choosing to invest in the U.S. for positive reasons. Who's right? We'll likely see in about 18 months, which is about the average time an inverted yield curve has led to a recession since the 1960s.  Chart from Bank of America, as cited in ZeroHedge
Household Debt on the Rise Remember those low interest rates we keep talking about? Well, apparently, your fellow countrymen didn't miss them, either. The latest data from the Federal Reserve Bank of New York shows that U.S. household debt is at an all-time high, presumably fueled by years of low rates.
Before anybody panics, remember: more borrowing is the point of low rates. By stimulating borrowing, and thus consumer spending and business revenues, low rates get a sluggish economy moving. At least that's how they're supposed to work. Critics said that low rates and abundant cash did more to inflate asset prices since the 2008 financial crisis than stimulate actual economic activity. One thing's sure: They've grown household debt, which now stands at $9.81 trillion for housing debt and $4.06 trillion for non-housing debt, like credit cards and car loans.
Basic financial theory says that as long as rates stay low—or fall further, as seems likely to happen—and employment stays high, household debt is not a big worry. But if rates creep up, especially at a time when unemployment has spiked (say, in a recession), then cash-strapped borrowers will be scrambling to make now-higher monthly payments. It's a risk, but not unlike how a doctor weighs the pros and cons of a medical procedure before making a recommendation, the U.S. Federal Reserve, Eric Rosengren notwithstanding, feels it's still best, on balance, for the economy.  Image from New York Federal Reserve
chart courtesy www.koyfin.com  Despite potential concerns regarding tariffs, shares of Home Depot still rose by over 4% today after its Q2 earnings beat estimates. Raytheon's stock price increased by almost 4% following Bank of America adding the company to its U.S. 1 List.  Although Kohl's second-quarter earnings best estimates, its sales did not—resulting in an almost 7% drop. Fellow department store chain Macy's was also unlucky; its shares losing almost 5% due to stagnant revenue growth.  Results from today were fairly mixed overall, with Nigeria being the closest to an outstanding winner. Europe suffered all over today, though it was Egypt that actually fell the furthest. Word of the Day: Proprietary trading refers to a financial firm or commercial bank that invests for direct market gain rather than earning commission dollars by trading on behalf of clients. This type of trading activity occurs when a financial firm chooses to profit from market activities rather than thin-margin commissions obtained through client trading activity.  Today in Financial History Aug. 20, 1932: Franklin Delano Roosevelt launches his presidential campaign with a proposal to better regulate Wall Street investment banks—their trading practices in particular—as well as commercial banks. The more things change, the more things stay the same.
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Tuesday, August 20, 2019
A Half-Step Back
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