And so, things took a wholly unfortunate turn into month-end.
Mercifully, Treasurys pared gains following a poor 7-year auction, and that gave equities a bit of respite, but it was still a tough day on Wall Street. It’s now abundantly clear that stocks have had more than enough of the bond rally.
In the simplest possible terms, the trade war and concurrent growth jitters have overwhelmed risk appetite.
US stocks are headed for what looks, to me, like their first four-week losing streak since 2014.
Already sour sentiment deteriorated markedly over the past 24 hours (top pane).
Although the prospect of China using rare earths as an economic weapon in the trade war is something that’s been discussed before, it got more “real” this week when comments attributed to a “relevant official” by CCTV on Tuesday set the stage for a Wednesday People’s Daily article that appeared just hours later. The message was clear: Rare earths are in fact under consideration when it comes to how Beijing might go about countering Trump’s next move.
That news is more important for the signaling effect than anything else. That is, it underscores how rapidly the situation is deteriorating.
Meanwhile, risk appetite wasn’t helped on Wednesday by Robert Mueller’s first (and apparently last) public remarks about the special counsel probe. Suffice to say Mueller did not deliver a ringing endorsement of the “No collusion/no obstruction” narrative.
High yield is starting to look shaky again. Investors yanked some $429 million from JNK on Tuesday, the largest outflow since December. The CDX HY index fell to its lowest since the end of January on Wednesday. JNK is riding a four-session losing streak and HY spreads have widened materially in May.
Obviously, collapsing crude isn’t helping the situation for junk. This is all part of the same “growth scare” trade – sentiment seems to have coalesced around the idea that we’re past the point of no return in the trade war and that presages demand destruction.
Right up until this week, you would have needed to put in at least a modicum of effort to notice that something was seriously awry. Developed market equities had held up ok, all things considered. But, as noted early Thursday, even a cursory glance across EM and/or under the hood in the US and Europe, reflected trade and growth jitters, with semis and energy stocks betraying large losses. Here’s a snapshot of returns across markets and sectors since Trump’s already famous May 5 Twitter broadside:
In the same note from which those visuals are excerpted, Barclays constructs a “Huawei basket” comprised of the names in the bank’s semiconductor coverage which have significant sales exposure to the embattled Chinese tech titan. Here’s a table:
The bank next makes what it calls “a crucial observation”, which is as follows:
…for the companies who have lowered guidance, the impact on earnings guidance is 2-3x that of the sales impact which simply reflects the high fixed costs and hence high operating leverage for these companies. While we don’t have explicit guidance for the other stocks, as a rough estimate we apply a 2.6x operating leverage to estimate the earnings impact for the full universe. The analysis reveals that although the price impact on the stocks has been quite substantial, the actual earnings impact is even more significant. Thus the worst case impact on prices (assuming constant valuations) is theoretically even more severe.
So, if your question is whether semis have priced in the worst case Huawei scenario, the answer would appear to be no – or at least not from where Barclays is sitting.
Amusingly, the SOX managed a meager gain on Wednesday amid the broader selloff.
It’s worth remembering that when Trump moved to blackball the company on May 15, it wasn’t readily apparent that most market participants appreciated the gravity of the escalation. That reality has set in over the past two weeks.
Barclays goes on to suggest that in the event China hits back at the US by cracking down on Apple, a bevy of names would be undermined. In the table below are names in Apple’s supply chain. Barclays cautions that while “the price impact on the stocks in the basket has also been quite substantial, if Apple becomes embroiled in the US-China spat, the downside risks to these stocks could be materially higher.”
All of this as the market again stares down the possibility of a budget crisis in Italy. In and of itself, that would be entirely manageable, but not against the backdrop outlined above.
Finally, note that insult is added to injury when you take a look at the dollar, which continues to push higher in 2019. As Nomura’s Charlie McElligott wrote late last week, it’s still pretty tight out there.