Charts of the Week
A look at China, US markets, and much more
Happy Monday! This Charts of the Week will be a lot of fun. Lots to dig into!
China May Want to Close Again
Things are not going well in China. Despite “re-opening” the government has been hesitant to stimulate the economy or financial markets in any reasonable size.
Exports are falling appreciably to just about everywhere, except Russia, where there is a growing alliance of convenience and necessity between the two countries.
China’s real estate market is an area of growing concern. High yield real estate debt is falling back to recent lows, but the bigger concern is the clouds forming around the broader RE industry in China, where two of the formerly largest developers are in dire straights, with Country Garden missing debt payments and Evergrande filing for Chapter 15 bankruptcy protection in New York.
Country Garden’s dollar bonds are deeply distressed, with the market pricing in a high likelihood of default.
The impact of falling exports as well as diminished imports, reduced internal economic activity like construction and consumption, has led to deflationary prints in both the country’s year-over-year CPI and GDP deflator.
China’s slowing economic growth is potentially the worst three-year trend since 1976. Once a fast growing country, it’s fair to say that China’s economy has likely matured, and is likely to slow for some time to come.
Chinese corporate debt appears to be pricing deflation, with an increasingly deep inversion vs US corporate 10-year debt, where yields are rising as Chinese debt yields fall.
Europe Slows as UK Services Inflation Grows
Europe is slowing into a potential recessionary environment, which could add additional pressure to the ECB to slow their rate hiking campaign, but on the other side some of the more embedded core inflationary pressures remain a concern for President Legarde.
In the UK the number of job vacancies per unemployed worker is still quite elevated, albeit lower than what we had seen recently. This takes some pressure off of the tight labor market there, but there is more work for the BoE to do.
Public sector wages soared 9.6% year-over-year, their largest gain in decades, and this remains a driver of inflationary pressure, particularly in services over in the UK.
Which is an area to watch carefully as we saw UK services inflation accelerate last month in July.
Household savings of the US consumer is nearly exhausted, which may drive more borrowing pressure as while inflation has slowed to some degree, prices have stayed elevated.
So elevated for the price of housing and capital, in fact, that it has created the lowest level of housing affordability on record. Locking many out of the American dream of owning their own home, or at least borrowing it from their bank with some degree of a stake in the property.
Rates, Rates, Rates
Asset managers are positioned for rates to peak here and fall, but will they? We think that given the resilience in the economy (particularly in services) that we may see rates rise more from here.
That doesn’t mean it will be a straight path upwards as we challenge key levels along the way, but it does mean that the long end could move higher than many expect.
The Fed is reducing their balance sheet. If you squint really closely you can see it towards the right side of the chart below. If not, you may want to fetch your magnifying glass. Some have argued we need a more aggressive tightening policy, particularly on balance sheet reduction. The Fed, for its part, has recently signaled that QT may continue even during the next rate cutting cycle.
The 10-year real yield is at a 14-year high, which seems to be one driver of a risk-off feel in markets during August as yields moved meaningfully higher.
Risk Seems Riskier than Usual
Gross leverage remains extremely high! Why does it matter? Because we cannot assume that hedge funds are always going to have trades go as planned If one or both sides of their book goes against them, this amount of leverage means they have a lot of flattening out to do.
Equities are looking more and more expensive as we see equity risk premium at the lowest level since June of 2004. The way this is calculated is by taking the expected earnings yield of the S&P 500 and subtracting the US 10-year yield from it.
The QQQ vs TLT divergence remains quite wide. Eventually it is likely that we see QQQ move down and TLT move up, meeting in the middle somewhere. What that point is remains a question, but given how overvalued equities are by multiple measures, it does suggest that at the very least stocks could see some further de-risking pressure unless earnings catch up meaningfully. With Q3 earnings season around the corner, we’ll be watching closely for and reporting on any signs of improvement or deterioration.
Net Fed liquidity is falling vs the S&P 500, which continues to hold up better in comparison. At least for now. The larger amount of Treasury issuance may change that picture a bit, however, particularly given the longer durations being sold.
Speaking of divergences, the MSCI world index NTM PE has diverged meaningfully from US 10-year TIPS, suggesting a meaningful catching down may be in order unless the picture changes.
The Shiller PE ratio also suggests that stocks are quite expensive here, given three sequential quarters of negative S&P 500 earnings growth and elevated valuations, with the current Shiller PE at 30.38 vs a mean of 17.05.
Fear Came Back
Late last week fear came back, particularly on Thursday, when the equity put/call ratio shot higher.
That fear also helped to push volatility higher among a variety of asset classes.
Retail have been net sellers since the July market peak, de-risking at a similar pace and peak to trough amount as we saw post-SVB.
European equity flows showed a large amount of shorting and some selling down of positions, but funds remain net long.
All of this selling combined with high rates on short-term paper has driven year-to-date inflows on global money market funds to record levels, at $925 billion. That’s more than the entire year of 2020!
Energy Exposure Increases
CTAs have increased their exposure to oil, but it is by no means extreme. Just normalizing to a long positioning bias as momentum has shifted higher.
There are fundamental reasons to consider energy exposure as well. Various projections, including Goldman Sachs Jet Fuel Forecast, are looking for appreciably higher prices in their latest revisions.
The Shadow Banking System is Bigger
An interesting chart from FT showing just how much larger the so-called shadow banking system has become vs the traditional banks. Whether or not this adds to systemic risk is up for debate, but it is important to at least be cognizant of the scale.
We Didn’t Work
As WeWork is approaching it’s inevitable unwinding, it’s worth looking back at the wild ride from $0.1B to $47B and back to $0.4B in market capitalization.
Will it be a harbinger of what’s to come in commercial real estate as office space utilization trends remain troubling low?
Jackson Hole and the Fed
The week after Jackson Hole often brings us an increase in stock prices. Will next week be the same or an outlier like 2022? It all rests on Chair Powell’s shoulders.
Market participants may want to be careful what they wish for from the Fed, however, as most Fed cuts come from weakness in financial markets driven by some kind of credit or economic event.
I hope you enjoyed this Charts of the Week! If you have any questions or feedback please leave them in the comments below. Have a great week ahead!