Earnings Season Opens | The WMA Weekly Market Wrap

October 23, 2019

I have written about this many times, of course, including at some length last week, but consensus game theory analysis suggests that the U.S. and China are likely to settle their trade differences before much lasting economic damage is done. Since both sides benefit from a deal, it only makes sense. The markets generally reflect this viewpoint, since they express the outlooks of many of the world’s great game theorists. Accordingly, when trade war news suggests that a deal is nearer, global stock markets rally and, when the news is more pessimistic about a deal, the resulting losses don’t linger.

However, I have been more skeptical of this view than most because (a) China wants to establish and assert itself as the world’s great power, not subordinate to or dependent upon the U.S. or any other country; and (b) China, as an authoritarian state and as a matter of history, is plenty willing and able (far more so than the U.S.) to foist hardship upon its people in order to gain what its leaders perceive to be some broader advantage. China thinks we’re weak.

In that context, the opening to the NBA season on Tuesday will provide an interesting test case. As almost everyone knows by this point (and as I also wrote last week), an October 4 tweet by GM Daryl Morey of the Houston Rockets expressing support for pro-Democracy demonstrators in Hong Kong more than a little unnerved the Chinese Communist Party — with the fallout including canceled NBA events in China and league commissioner Adam Silver meeting with the Los Angeles Lakers and Brooklyn Nets in China during their preseason tour. That meeting featured LeBron James and other players speaking out against Morey and, implicitly at least, against free speech and democracy itself.

Despite substantial criticism, LeBron doubled down on his rhetoric upon his return home. Rockets’ star James Harden offered an unqualified apology. Nets owner Joe Tsai, a Chinese national, was similarly subservient. Significantly, China is the source of 10-15 percent of NBA revenues. Since the Morey tweet, 11 Chinese companies who partner with the NBA have suspended their working relationships with the league and China’s main television outlet CCTV has suspended broadcasts of NBA games. Tencent, which has a $1.5 billion deal to stream NBA games in China over the next five years, has stopped showing Rockets games but has not totally dropped all NBA content.

On Thursday, Silver admitted that the league’s losses as a result of the situation “have already been substantial.” He added that the league has faced pressure from China to fire Morey, but that it will not give in to that pressure (despite significant early missteps by the NBA in responding to the problem). China denies Silver’s claim. “I felt we had made enormous progress in terms of building cultural exchanges with the Chinese people,” Silver said. “Again, I have regret that much of that was lost. And I’m not even sure where we’ll go from here.”

As with trade, “most observers” expect the NBA’s problem with China to go away: “Business will return to normal because it’s good for both sides.” Accordingly, the opening of the NBA season on Tuesday will be worth watching for reasons far beyond on-court wins and losses. If the games are not broadcast in China and business does not go back to normal soon, my skepticism about a comprehensive U.S. trade deal with China would seem a bit more plausible.

In last week’s market action, most of the major domestic stock indexes recorded modest gains on the backs of some upside surprises in third-quarter earnings reports. The gains brought the large-cap S&P 500 within 0.65 percent of its record high on Thursday morning before falling back to close the week. The small-cap Russell 2000 outperformed last week, although it remained in correction territory, down over 10 percent from its August 2018 peak. Health care shares outperformed within the S&P, while technology shares underperformed. Despite the upside surprises, analysts polled by FactSet expect overall earnings for the S&P 500 during this reporting period to have declined slightly for the third consecutive quarter.

Enthusiasm over earnings reports may have been restrained by the week’s economic data, which missed expectations on several fronts. On Tuesday, the International Monetary Fund cut its 2019 growth forecast for the global economy from 3.2 to 3.0 percent, citing the drag from rising trade tensions.

The week’s most discussed data point may have been an unexpected 0.3 percent decline in U.S. retail sales in September, the first drop since February. However, core retail sales (excluding auto sales and purchases at gas stations and building materials stores) rose slightly in September, and core sales in August were revised higher.

The yield on the benchmark 10-year U.S. Treasury note ended slightly lower for the week at 1.76 percent. The safe-haven bid for Treasuries led to volatility as news arrived about a revised Brexit agreement, sending the British pound sharply higher. Subsequent reports about the agreement and its waning likelihood of passage in the UK Parliament, coupled with the weak U.S. retail sales data, caused intraday yields to fluctuate throughout the week.

Equity markets in Europe were mixed last week, largely due to the Brexit news. Reports of a sharp contraction in the Chinese economy also pressured global stocks, setting off a fresh round of worries about slowing global growth. For the week, the pan-European STOXX Europe 600 was flat, the exporter-heavy German DAX was up 1.4 percent, and the UK’s FTSE 100 fell about 1 percent.

In Asia, Japan’s Nikkei 225 jumped 3.2 percent last week on expectations of monetary easing. Meanwhile, Toyota Finance is said to be preparing to issue Japan’s first zero interest rate corporate bond. Stocks in China posted a weekly loss after the country’s third-quarter economic growth missed forecasts, underscoring the continued toll of the U.S. trade battle and raising the recession risk for the global economy.

From the headlines…

U.K. Prime Minister Boris Johnson’s government and the European Union surprisingly agreed to new terms for the country’s exit from the bloc Thursday, paving the way for a high-stakes vote in the British Parliament. Yesterday’s delay vote by the House of Commons may become a defeat for Johnson.

China’s economic growth slowed further in the third quarter to 6 percent, landing right on the central government’s full-year baseline target for gross domestic product as business activity continued to deteriorate in the world’s No. 2 economy.

Investors should avoid being misled by developments that cast complex and festering issues in a positive light. For example, announced “deals” on Brexit and U.S.-China trade are improvements, but only marginal ones, at least to this point. Much work remains to be done.

strong dollar continues to eat into the profit margins of American companies, contributing to what is expected to be 2019’s weakest quarter for corporate earnings.

U.S. manufacturing production fell in September, adding to evidence that slowing global growth and trade frictions are weighing on the economy.

U.S. retail sales, which had been the highest-flying piece of American economic data for most of the year, fell in September for the first time in 7 months, raising fears that the U.S. manufacturing recession may be bleeding into the consumer side of the economy.

The Ivy League endowment investing strategy is losing luster.

Fisher Investments has seen a growing backlash since the firm’s founder made offensive comments about women. The firm has lost over $1 billion in assets under management.

Institutional investors representing some $10 trillion in assets under management were recently surveyed and asked which trends would drive global economies and the resulting investment landscape over the next three decades. The top ten responses are listed below.

·     Aging population (78%)

·     AI and machine learning (69%)

·     Impact of climate change (66%)

·     Urbanization and smart cities (42%)

·     Redefining global trade (40%)

·     Personalized medicine (27%)

·     Electric and autonomous vehicles (23%)

·     Depleting natural resources (22%)

·     Privacy (13%)

·     Population growth in Africa (13%)