This guest commentary was written by Mike O'Rourke of JonesTrading and published on October 1.
The August ISM Manufacturing report was released a month ago on September 3rd.
That print of 49.1 was below the estimate of 51.3. The S&P 500 settled 0.7% lower that day in response to the report. At the time we described the report as follows “We will be the first to note that one reading does not make a trend and throughout 2019, we repeatedly noted the strength of the economic data. That said, this report should serve as a major economic canary because it likely foreshadows further weakness in the future.”
Then, over the course of the next 7 trading days the S&P 500 rallied 4.5% to its most recent highs of 3020. Today, the S&P 500 declined 1.2% following an even more disappointing September ISM Manufacturing report. Ironically, despite the ISM’s further deterioration and today’s equity market weakness, the S&P 500 settled today 1.2% above where it settled on September 3rd. It is another example of the equity markets broken pricing mechanism. It has become easy to find such examples on a daily basis.
There were reasons for last month’s rally. Eleven days earlier on Friday August 23rd that the China announced its retaliatory tariffs that enraged President Trump. Trump responded by “ordering” US companies home from China and increasing the tariffs in place and those planned for September 1st. Ironically, the S&P 500 had recovered nearly all of its losses by September 1st when that round of tariffs was partially implemented (with the balance delayed until December 15th).
On September 4th US based investors walked into a market where several global headwinds faded overnight. Hong Kong shelved the extradition bill at the heart of its protests. Italy was able to form a pro-EU government thwarting The League’s Matteo Salvini’s gambit to gain sole power. The UK Parliament was successful in its concerted efforts to check Boris Johnson’s Brexit efforts. The positives fueled the subsequent rally along with the agreement by the US and China to resume peace talks. The reason we list this entire back story is because it should abundantly clear that with the exception of Italy, all of these headwinds remain outstanding.
The previously listed headwinds have been joined by an impeachment inquiry, financial instability in the repo market, a breakdown of the IPO market and the investor recognition that many of the Unicorn valuations are unrealistic. Only Wall Street and venture capitalists reward unsustainable cash burning business models with valuations in the tens of billion of dollars. Price wars are breaking out everywhere, streaming most notably, but today it was in the brokerage space.
The President’s deteriorating position has give market clout to the rise of a political opponent, Senator Elizabeth Warren. Warren has clearly identified Health Care, For Profit Education, Ratings Agencies and Big Tech as corporate targets she plans to crack down on. Warren’s twitter attacks on Big Tech today, especially Facebook were Trump-like.
We have argued that despite the S&P 500’s 18% year to date gain the outlook is far murkier than it was a year ago. One can sincerely say the outlook is far murkier today than it was a month ago. Today’s ISM Manufacturing reading of 47.8 was the weakest reading since June 2009, the final month of the Great Recession.
The reading knocked the Atlanta Fed’s GDPNow forecast from 2.1% on Friday to 1.8% today. Reuters is reporting that it may be JPMorgan at the heart of the “repo madness.” That would be extremely disconcerting, we would expect risky behavior from smaller less sophisticated institutions, but not the pride of the industry with a “Fortress balance sheet.” We started this note stating that examples of the market's broken pricing mechanism are a daily occurrence. That means there are more mispriced assets than anyone is truly aware of.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor research note written by Mike O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.