Financial Review

Double Dog Dare

….Playing chicken with North Korea and stocks fall. How markets respond. Don’t forget tax reform and debt ceiling. Opioid emergency. PPI fell. Retailers slip, mainly. 2016 hottest ever.

Financial Review by Sinclair Noe for 08-10-2017

 

DOW – 204 = 21,844
SPX – 35 = 2438
NAS – 135 = 6216
RUT – 24 = 1372
10 Y – .03 = 2.21%
OIL – 1.00 = 48.56
GOLD + 8.90 = 1286.80

 

The S&P 500 declined 1.45 percent, the worst decline since May. The Nasdaq composite dropped 2.1 percent, with Apple, Alphabet, Amazon and Netflix all trading lower. It was a broad-based decline on Wall Street. The CBOE Volatility Index (VIX), a gauge of fear in the market, soared more than 40 percent to trade at 15.98. It also hit its highest level since May.

 

President Trump said North Korea would face “fire and fury” if it threatened the United States. North Korea dismissed the warnings as a “load of nonsense”, and outlined plans for a missile strike near the Pacific territory of Guam. And today, Trump ratcheted up his rhetoric, saying his “fire and fury” comments may not have been tough enough, and North Korea should be “very, very nervous”.  China is the largest trading partner with North Korea and China has called for dialogue to end the crisis but has otherwise been pretty quiet. China’s interests do not include a unified Korean Peninsula.  When it comes to assessing global geopolitics like the situation with North Korea, we don’t know how this will play out. It could be a brilliant bluff or it could be very dangerous bravado.

 

Here’s what we might see in the marketplace: stocks tend to react badly to the prospect of war but the exact reaction varies significantly, Treasuries generally move higher – pushing yields lower (The yield on the benchmark 10-year note touched 2.20 percent Thursday, its lowest level since June, although it is worth noting that junk bonds have taken a hit recently – and that may be separate from concerns about war; the cost of protecting high-yield bonds against default in the credit-default swap market has climbed to the highest since mid-July), oil and other commodities tend to jump ahead of a geopolitical event and sell off afterwards. And of course, gold has started to shine again. Pimco told investors to pare U.S. equities and junk bonds, but keep exposure to real assets, such as inflation-linked debt, commodities and gold. T. Rowe Price cut its stock allocation to the lowest level since 2000. Morgan Stanley strategists said investors should consider betting against U.S. junk-bonds as recent price weakness may be the beginning of a correction. Geopolitical turmoil tends to drive volatility but not necessarily trends. In other words, the contrarian play usually works. Warren Buffett has described the strategy as “stay calm when all hell breaks loose.”

 

Meanwhile, it is a big distraction from other issues such as tax reform, the debt ceiling and healthcare – which you probably thought was a moot point by now. Senate Majority Leader Mitch McConnell is refusing to sign-up for an ambitious White House timeline on tax reform that calls for legislation to sail through by fall. And he’s now engaged in an extraordinary war of words with the Trump White House. McConnell said he thought Trump “had excessive expectations about how quickly things happen in the democratic process …” This drew a sharp rebuke from Trump and his senior aide Dan Scavino. The White House is going to need good will from McConnell on tax reform. And they’ve already blown through the initial, absurd, August deadline. Increasing pressure and publicly ripping McConnell is going to make tax reform and the rest of Trump’s agenda even harder to pass.

 

Meanwhile, there is a very real deadline for a deal on the debt ceiling. Mark your calendar. You can see this one coming: The government will run out of cash on Sept. 29 and cannot borrow more money unless Congress raises the debt ceiling. This is a perennial crisis, and markets have a well-rehearsed pattern of worry followed by relief. Lawmakers are on recess until Sept. 5, and they plan to take a week off in September. So that leaves 12 working days for Congress to raise the borrowing limit. It’s difficult to give Congress the benefit of the doubt on getting this done. The White House is usually focused on this priority, but in the wake of the health-care defeat in the Senate, White House budget director Mick Mulvaney initially said that Congress should hold off on all other issues, including the debt ceiling, until it went back to health care. He later changed his position and said Congress should raise the debt ceiling. McConnell and House Speaker Paul Ryan will push for a clean debt ceiling increase, but some number of more conservative members will vote against that, meaning Democrats will need to provide votes to ensure a successful vote. But it’s not clear what conditions Democrats will demand in exchange for their votes. Senate Minority Leader Chuck Schumer said earlier this summer that Democratic votes may be hard to come by if Republicans insist on passing a large tax cut for the wealthy. And the White House is pushing for funding for a border wall with Mexico to be included in a debt bill, in exchange for lifting spending caps. PredictIt has become the go-to prediction market for observing U.S. political events. PredictIt offers weekly debt ceiling markets through the end of October, and at the time of this writing, its participants give less than a 5 percent chance of the debt ceiling being raised by Sept. 15, and less than a 15 percent chance of it being raised by Sept. 22. If the Trump administration’s Sept. 29 estimate is right, then we could be looking at another tense period for markets like we had in the summer of 2011, when the debt ceiling standoff caused Standard and Poor’s to lower the U.S. credit rating. Of course it’s possible the real deadline will be a week earlier or a couple weeks later, given volatility in tax receipts. So, if you mark your calendar, be sure to use a pencil.

 

Also, today, Trump declared the opioid epidemic a national emergency and said his administration was drafting papers to make it official – this comes about a week after a White House commission on the opioid crisis led by New Jersey Governor Chris Christie recommended the president declare it a national emergency. The declaration could help unlock more support and resources to address the drug overdose epidemic, such as additional funding and expanded access to various forms of treatment, and it gives the government more flexibility in waiving rules and restrictions to expedite action. National emergencies are typically declared for short-term crises, such as the Zika virus outbreak or a natural disaster. It is unclear what Trump’s declaration will mean for a complex, long-term public health problem.

 

Producer prices fell in July, recording their biggest drop in nearly a year and pointing to a further moderation in inflation that could delay a Federal Reserve interest rate hike. The Labor Department said its producer price index for final demand slipped 0.1 percent last month, weighed by decreasing costs for services. That was the largest decline since August 2016 and reversed June’s 0.1 percent gain. In the 12 months through July, the PPI increased 1.9 percent after rising 2.0 percent in the year through June. Core PPI, which excludes food, energy and trade services was unchanged last month. The core PPI increased 1.9 percent in the 12 months through July.

 

Shares of retailers Macy’s and Kohl’s declined after quarterly results failed to assure investors that a comeback was taking hold. Same-store sales dropped 2.5 percent at Macy’s and 0.4 percent at Kohl’s. Dillard’s sank as much as 16 percent to $61.50 after posting a surprise loss in its second quarter. Lots of people like to talk these days about how the retail industry is undergoing a structural shift due to changes in how consumers like to shop. But weakness in the retail sector is probably being impacted by consumer debt as well. Household debt outstanding — everything from mortgages to credit cards to car loans — reached $12.7 trillion in the first quarter. Household net worth stands at a record $94.8 trillion, thanks to rebounding home values and soaring stock portfolios. But that increase has primarily benefited the nation’s wealthiest. For most Americans, whose median household income, adjusted for inflation, is lower than it was at its peak in 1999, borrowing has been the answer to maintaining their standard of living. The average family of four is living paycheck to paycheck.

 

And just when you think you’ve got it all figured out. Nordstrom reported second-quarter earnings and sales that topped analysts’ expectations, sending shares of the stock higher after market close. Same-store sales were also positive, a rare outcome among department stores of late. Nordstrom said its results this period were fueled by more customers ringing up purchases online. Nordstrom’s stock was last climbing more than 3 percent higher in after-hours trading on the news.

 

Graphics chipmaker Nvidia saw its stock fall more than 7 percent after it reported stronger-than-expected earnings for the second quarter. Earnings came in at $1.01 per share, topping estimates of 70 cents. Revenue was up 56 percent year over year and beat estimates. They raised guidance slightly.

 

A new international report has confirmed that 2016 was the hottest year for the planet in 137 years of record keeping. It was the third year in a row to break the record. The report was released by the American Meteorological Society. Almost 500 scientists from more than 60 countries participated in the project. Global sea surface temperatures reached a new record high, and Arctic sea ice extent at the end of its annual growth season was at its lowest maximum level in the nearly 40 years of satellite records. Every month, at least 12 percent of land surfaces were in severe drought conditions or worse — a record long stretch.

 

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