Hello and welcome to the Friday
edition of Before and After,
the twice weekly market show from
Refinitive.
As you know, our goal is to look at
the possibilities around events that
will shape the markets in ways both
big and small.
Today, we will discuss Japan's
machinery orders and the upcoming
Spanish elections and we go back
and look at the non manufacturing
ISM for our after study.
Let's get right into it with Japan's
machinery orders.
Arguably, the manufacturing slowdown
that swept across the world started
in the Far East when China put
the brakes on its credit fueled
growth. Now, clear signs
of weakness have turned up in areas
as far apart as Asia, Germany,
and now even with the US
manufacturing data.
This weakness has investors
concerned that this slowdown will
turn into a full blown recession and
yet in recent weeks, we've
seen equity markets in some of the
most affected places starting
to rip higher.
Germany, Taiwan and Japan
and the US is making all time highs.
Are Equity markets getting ahead of
themselves or are they pricing
in a turn that we haven't yet seen
in the data?
Japan's proximity to China
and its heavy exposure to industry
has counted against its economic
well-being over the last year, and
its quarterly GDP has been flirting
with zero growth over the last few
years. Not to mention merchandise
export growth has been in negative
territory throughout all of 2019.
One of the key indicators of health
of the manufacturing sector is the
performance of Japan's machinery
orders.
Last month, the year on year number
hit its lowest level since 2014,
the last time the global economy
suffered a significant manufacturing
slowdown, but, if
global equity markets are right,
shouldn't this number be bouncing
from these lows?
The latest poll of economists is not
exactly optimistic, forecasting
a year on year decline of ten point
eight percent.
Yes, that would be an improvement on
the previous month, but it would
still be one of the ten worst
readings since 2010,
hardly indicative of a global
manufacturing economy that's made it
through the worst.
So what should we expect?
Bond yields are unlikely to react as
the Bank of Japan has that market
all sewn up.
Strong data should weaken the
Japanese yen because if global
growth is truly turning higher, then
Japanese investors will take more
overseas investment risk selling
yen to buy foreign assets.
Most of the action should therefore
take place in the equity market.
If the year on year number is
another shocker and that's got to be
anything worse than the forecast of
minus ten point eight per cent,
then we'd be looking for profit
taking on the Nikkei 225
which are Refinitive charts shows us
has gained 15 % since the summer.
If it's worse than the previous
month below
-14.5%, then global investors
should be reevaluating their
newfound optimism.
Anything above -4%
and this could indicate that the
global manufacturing sector is
indeed attempting to reverse engines
and that global equity indices have
correctly predicted a bottom in the
cycle of manufacturing weakness.
Either way, this will be a key
signpost on the way to understanding
the health of global manufacturing.
That's what's happening in Japan.
What else is going on across the
globe that might interest investors?
This next before topic could
certainly be seen as an after
because for the fourth time in four
years, Spain is heading back to
the polls. On the heels of the no
confidence vote in Prime Minister
Mariano Rajoy, amidst a massive
corruption scanda, Prime Minister
Pedro Sanchez of the center left
Spanish Workers Socialist Party
was elected without a clear
majority. Without cross-party
support, he has failed to form a
consensus government by the
September 23 deadline.
The severe jail terms recently
handed out to Catalonian
separatists, which has ignited
unrest in the region, will add
another layer of tension.
There is the distinct possibility
that Sanchez joins Italy's Matteo
Renzi and the UK David Cameron
in falling to another populist
backlash.
European elections are seemingly the
EU's ever present banana skin.
European leaders probably don't mind
another hung parliament, but they
would cringe at the thought of
another European bastion of eurozone
conformity falling into the hands
of a populist party.
Very few expect that there will be
an outright victor.
Most expect there will be a
coalition. But the question is, will
it be left leaning or will it be
right leaning?
And how populist will it be?
Spain is heading to the polls with
home sales that are on the slide
and an economy that is slowing.
Here are the market instruments we
should be paying attention to.
In Spain.
Spanish 10 year bond yields and
Banco Santander is common stock are
a good place to start.
Yields have been compressing on the
back of the global bull market in
bonds, with Spain's 10 year recently
reaching their lowest level ever.
Look at our Refinitive chart.
We see that Santander is one of the
largest members of the IBEX 35
and of course, Spain's biggest
and most important bank.
Santander stock is hovering near
its 20 year lows and in constant
jeopardy of plummeting through
support.
Down 6 percent on the year.
It's the real reason why Spain's
IBEX is only up 10 percent and
lagging the other European major
indices in 2019.
An outright, though unlikely victory
with either the Socialists or the
conservative Popular Party
would provide some relief for
Spanish assets.
The IBEX should outperform Europe on
that outcome. After all, it does
have a lot of catching up to do.
Most likely is that a coalition will
need to be formed with one of the
other main parties, the center
leaning Cuidadanos, the socialist
Podemos or
the right wing VOX party.
The risks are that the populist, far
right or far left leaning parties
gain a much stronger hand.
The European project has come under
fire from populists and this could
unsettle the bond market and bank
stocks. Remember what happened in
Italy when election uncertainty
picked up?
Italian bond yields had a nasty
spike in the middle of 2018,
and a repeat in Spain would hurt the
bank stock too, with repercussions
across the eurozone banking sector
that has recently been enjoying a
rally. Of course, there's always
a decent chance that this election
again fails to break the deadlock
that would leave Spanish assets,
treading water and looking for
a life preserver in the form of
external influences to decide
their direction.
Ultimately, the big hope for markets
is that a clear victor emerges
because that delivers certainty
regardless of political persuasion.
Time to look back at the non
manufacturing ISM and see what
we can learn from what happened
after the market reacted.
We theorized that a rapid rebound
from the previous month lows should
see risk assets head off to the
races.
Confirmation of a slowdown would
lead to worrie, but then again, the
expectation of even more
accommodation from the US Central
Bank.
Good news, it looks as though the
economy is not collapsing after
all. Non manufacturing ISM
came in stronger at
54.7 versus an expectation
of 53.5.
This was a decent rebound from the
three year low.
This gave the market a slight pop
before ultimately giving up on those
gains.
Given this was a beat, maybe market
participants are not nearly so
worried about the slowdown, as many
headlines would have us believe.
In fact, it looks like the case for
a robust economy has been properly
valued. After last week's very
strong payrolls.
Again, it's going to be difficult to
get a strong risk on bid with
equities at all time highs,
even with very solid numbers going
forward.
It may even be that from this point
on good data is bad news
because it will price out the
likelihood of further rate cuts in
the US.
As we all know, global equities
love rate cuts and liquidity
injections more than they love
economic growth.
And remember, the US has not
fallen into recession in the last 20
years when this data point has been
above 50.
That's it for this episode of Before
and After the twice weekly market
show from Refinitive.
I'm Jamie McDonald.
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I'll be back on Tuesday.