Ta-ta, TINA. That’s as in “there is no alternative,” which has been the description of common stocks in recent years while interest rates hovered near zero.
But TINA is getting dumped by investors who, according to Bianco Research’s Ben Breitholtz, are having a “new love affair with cash.” Not literally the folding green stuff, but supersafe, ultraliquid investments. Exchange-traded funds investing in short-term government securities recently have been attracting 33 cents out of every dollar going into ETFs of all asset categories, he wrote on the Bianco website early in the week.
That’s confirmed by the stampede into Treasury bills by the Thundering Herd, according to Bank of America Merrill Lynch’s global investment strategy team led by Michael Hartnett, as the firm’s clients ramp up their holdings of the safest, most liquid investment on the planet. As noted here last week, short-term T-bills provide nearly the same yield as dividends on the S&P 500, which may be why TINA seems a bit fey these days.
Hartnett & Co. also note that equity funds suffered their second-biggest weekly outflow, some $29.7 billion, last week. Since the beginning of the year, there has been a big turnaround in flows into equities. From a gusher of $103 billion in the first five weeks of 2018, when stocks seemed on an unstoppable ascent, the inflows slowed to $31 billion over the next five months, before reversing to a $50 billion outflow in the most recent five days.
Those outflows probably weren’t helped by Monday’s stock swoon, which featured a 2.1% drop in the Nasdaq Composite, supposedly over feared curbs on Chinese investments in the U.S. as part of the escalating tariff war. While many components in the tech-heavy index would be hurt by curbs on trade and investment, among the biggest losers that day was Netflix (ticker: NFLX), which shed 6.5% on the session, and which would hardly be affected by any tariff dispute. More likely, some profits were being cashed in ahead of the end of the quarter and the half-year, as the “N” in FANG was still up over 100% for the year after Monday’s drop.
Big Tech still has been 2018’s big winner, with the Invesco QQQ Trust (QQQ), which tracks the biggest Nasdaq stocks, posting a total return of 10.63% for the year through Friday, according to Bloomberg, with 7.43% coming in the past three months. For the broader large-capitalization sector, the SPDR S&P 500 ETF (SPY) returned 2.54% year to date, boosted by a 3.56% return in the past three months. Small-cap stocks, supposedly less affected by global factors, also were winners; the iShares Russell 2000 ETF (IWM) returned 7.66% for the year through Friday, with a bit more (7.86%) coming in the past three months.
At least all of those numbers had plus signs, something that China’s stock market can’t boast. The decline in the Shanghai Composite put it into bear market territory with a drop of more than 20%. Trade tensions appear to be weighing more heavily on the Chinese market, which also has had to cope with a slowing domestic economy.
What’s got global market watchers worried is that China’s stocks are sliding in tandem with its currency, the renminbi or yuan. Until recently, the yuan had been declining versus a rising dollar; relative to a basket of its trading partners’ currencies, it actually was up 5% over the past year, according to JPMorgan global markets strategist Nikolaos Panigirtzoglou. In the past two weeks, however, the yuan has slid 3.5% against the greenback, 2% on a trade-weighted basis—big moves for a currency that is relatively tightly controlled by Chinese authorities. The central bank also lowered the required reserve ratio, injecting the equivalent of $100 billion into the banking system to counter the impact of the tariffs, which also tends to weaken the yuan.
That suggests China is using the exchange rate as a weapon. “The most effective way for China to retaliate [against] rising U.S. tariffs is to weaken” the yuan, according to the July Bank Credit Analyst. That could roil financial markets, however.
The dual declines in China’s equity market and currency are raising concerns of a repeat of 2015. Treasury strategists at NatWest Markets recall that the drop in the yuan that summer sparked severe equity market losses, including a 10.5% correction in the S&P 500. China’s currency is also having an impact on emerging markets, especially those in Asia, which have already been under pressure from the tightening of Federal Reserve policy (as well as local factors in Brazil and Turkey). “It seems like this is a particularly vulnerable time for the currency of world’s second-largest economy to be accelerating” lower. For that reason, the yuan is the first thing they say they check in the morning.
“In all, the combination of equity market declines and currency depreciation pressures revive memories of 2015, and this combination has the potential to unsettle risk markets,” Panigirtzoglou concludes. One more reason to abandon TINA for T-bills.
Could the factor that precipitated the disturbances in the markets in early 2018 re-emerge to roil them anew in the second half? David Levy, who heads the Jerome Levy Forecasting Center, thinks it could.
The bond and stock markets were rocked after the release of the January employment data, which showed average hourly earnings rising at a 2.9% year-over-year rate. Those unexpectedly rapid pay gains aroused market fears of more aggressive interest-rate increases, which in turned spurred sharp selloffs in stock and bonds with a surge in volatility.
While worries about the Federal Reserve and its reaction to inflation have since eased, Levy thinks the markets’ equanimity (or complacency, depending on how one views it) could be upset. “Indeed, accelerating pay rates are likely to provide a big surprise in the second half, potentially dominating interest-rate behavior along the way,” he writes.
Economists, including those at the Federal Reserve, have been generally nonplussed by the relative modest rise in pay, as the labor market reached—and surpassed, by most definitions—full employment with the headline jobless rate of 3.8%.
“What many people do not fathom is that labor markets do not tighten in consistent, linear fashion as worker availability diminishes and then scarcities intensify,” Levy says.
It appears that the jobs market is at, or close to, that tipping point. In particular, the latest Job Openings and Labor Turnover Survey, or Jolts, showed more job openings than job seekers. Another barometer: The National Federation of Independent Business found the largest share of small businesses raising compensation in 34 years in May.
Yet, Levy continues, a generation of investors and managers have not experienced any persistent rise in inflation. Since 1995, the core consumer-price index, which excludes food and energy, has not exceeded 2.5% annually by much or for long. They also have no memories of the 4% to 5% inflation of the late 1980s, let alone the double-digit inflation of the late 1970s and early 1980s. And the false alarms about inflation as the jobless rate has declined have made all of those earlier increases seem like ancient history.
Economists have theoretical debates about the ability of central banks to set an ideal interest rate to keep the economy controlled “as if setting a clock.” But these ignore the real world. Employers in strong sectors, such as plumbing contractors, truckers, and the oil industry, are having to compete aggressively for workers. “Indeed, when businesses start losing employees because of better offers across town, it may be much more alarming than when a growing company cannot find workers to add,” Levy writes.
If labor does truly gain the upper hand and starts to see pay gains, the possible sustained increase in inflation could make this workers’ paradise short-lived, he continues.
“That is because acceleration in inflation virtually assures [that] rising interest rates amount to a death sentence for financial stability here and abroad: Either the Fed would have to raise interest rates much more than private balance sheets here and abroad can tolerate, or else markets would price in future Fed hikes that would do similar damage,” he concludes.
The capitalist class would suffer first, Levy suggests. Higher rates would hit global financial market conditions and domestic asset markets before they could materially weaken the economy.
There is an alternative scenario in which higher labor costs do not feed fully through to prices. Businesses may not be able to pass on higher costs and absorb them instead, to the detriment of profit margins. The recent U.S. corporate tax cuts provide more leeway for businesses, but tighter margins aren’t a plus for earnings growth.
In any case, Fed Chairman Jerome Powell has pointed out that the past two recessions followed financial unrest, first after the bursting of the dot-com bubble in 2000 and then the financial crisis of a decade ago, rather than inflation. The market eruptions of early February suggest how inflation could feed into financial instability.
For that reason, the June jobs report due out on Friday should provide the main action in the coming holiday-interrupted week. Even more than the payrolls data (a gain of 185,000 is the consensus forecast, solid but short of May’s 223,000 rise), average hourly earnings are expected to attract scrutiny. Those data are forecast to show a 2.9% year-over-year increase, the same gain that roiled the markets five months ago. A number with a “three handle” could spark some post–July Fourth fireworks in the markets.
Write to Randall W. Forsyth at firstname.lastname@example.org