Bad News Is Good News — For Now

Stocks take the stairs up and the elevator down — so runs an old market wheeze.

Monday and Tuesday stocks stampeded into the elevator… and plunged earthward.

The Dow Jones sank a combined 800 points. Thus a month’s worth of gains vanished into the electricity.

Depressed manufacturing data at home and abroad brunted much of the blame.

And today?

Stocks found their legs at opening bell, and started up the staircase.

But shortly after 10:00 Eastern, they took fright… and lit out for the elevators… again.

By 10:15 the Dow Jones was sunk another 300 points.

And investors were paddling into safe harbors like Treasuries and gold.

What sent stocks scurrying for the elevator this morning — and investors for safety?

More Distressing Economic Data

It was not the manufacturing sector. Instead it was the service sector…

The latest service sector report from the Institute for Supply Management came issuing at 10 a.m.

Any reading above 50 represents service sector growth. A Dow Jones survey of economists projected a 55.3 reading.

It came in at 52.6 — growth, yes — but its lowest reading since August 2016.

The service sector represents nearly 70% of GDP… and 80% of private-sector employment.

A slacking service sector therefore suggests a downgrading economy.

Stack the service sector data atop the manufacturing data. A woeful image emerges.

Reports MarketWatch:

Up to now, industries like finance, technology and construction have been largely insulated from the impact of import tariffs and slowing trade, but Thursday’s data could suggest cracks are forming in a foundation of the U.S.’ expansion.

“Look out below,” adds a perspiring Chris Rupkey, chief financial economist for MUFG:

Look out below is what purchasing managers from services industries are shouting at the markets as the fears of recession continue to mount. Stock investors don’t like that the doom and gloom in the manufacturing sector is starting to infect the bigger part of the economy that employs millions of workers in services industries including health care, retailing, business administration, accounting, computer services, on and on.

Ah, but lest ye forget…

Bad News Is Good News

Bad news is often good news in today’s deformed and deranged markets.

Bad news means the Federal Reserve will hatchet interest rates.

Ergo, today’s poor economic report means the Federal Reserve will cut rates later this month.

Encore ergo, the stock market got off the elevator this morning.

Shortly after this morning’s report, federal funds futures gave 92.5% odds — in favor — of a rate cut later this month.

Only one week prior those odds were 49.2%.

By 11:00 a.m. stocks were climbing the stairs again. And all major indexes soon crossed into green.

There they remained through the closing whistle.

The Dow Jones gained 122 points on the day. The S&P added 22, the Nasdaq 87.

But we are unconvinced additional rate cuts will excite the animal spirits for long.

Will Rate Cuts Be Enough?

As we reported Tuesday, corporate inside men are offloading their own stocks at the greatest clip since 2000.

That alone is no red-handed evidence of lean times ahead. But these fellows understand their business prospects best.

And we hazard they are selling against a diminished outlook.

Now let us heap Pelion upon Ossa…

A central pillar of market support begins to creak and groan… and may be giving way.

We here refer to stock buybacks.

In reminder, buybacks reduce a corporation’s total number of stock shares outstanding.

They therefore elevate earnings per share. That in turn elevates the share price.

Buybacks are thus the handiwork of the financial engineer. And the higher stock prices they bring result from sorcery… not from expanding profits.

Have Buybacks Peaked?

The buyback delirium owes to the kindly influence of the Federal Reserve.

Depressed interest rates have enabled corporations to borrow at cutthroat rates. These borrowings they plowed into buybacks.

Corporations have emptied some $4.2 trillion into buybacks since 2013. Corporations — in fact — have been the largest purchasers of stocks this past decade.

And buybacks ran to over $1 trillion last year… a record.

“[Their impact] is so profound,” argues CNN Business, “that some worry about how stocks will hold up without them.”

The answer may be forthcoming…

Second-quarter buybacks for S&P components dropped 20% from the first quarter. Year-over-year buybacks have fallen a similar 19%.

“Total S&P 500 buyback amounts seem to have peaked…” laments Sean Darby, global head of equity strategy at Jefferies Financial Group.

Who will be left to buy if this pillar gives out?

The Unsustainable Corporate Debt Bubble

Meantime, corporate debt rises to nearly $10 trillion — nearly 50% of U.S. GDP — a record.

According to Morgan Stanley… corporate liabilities relative to income have attained their highest ratios since 2009.

And some “40% of investment-grade companies now have obligations that are more consistent with junk ratings.”

How much more debt can they take on… before rupturing like an over-heliumed party balloon?

Bloomberg informs us that:

Third-quarter credit rating downgrades exceeded upgrades at the greatest clip since 2015.

S&P Global Ratings handed out 164 third-quarter downgrades. It only issued 64 upgrades.

Once these wobbling corporations begin defaulting on their obligations… the dominos will start going over.

A cascade of failures would likely raise the curtain on the next financial crisis.

But, we offer no specific forecast. The timing — as always — is on the knees of the gods.

But the next economic hammer-blow could come clouting down tomorrow.

That is the September unemployment report…

The Worst Projected Jobs Report in Seven Years

Economists hazard the private sector added a mere 130,000 jobs last month.

As Bloomberg informs us, that is the weakest monthly projection in seven years.

The only exceptions were months affected by hurricane (2017)… and government shutdown (2013).

We shall see tomorrow morning.

In all, the United States economy is projected to add 1.9 million jobs this year — the slenderest gain since 2010 — and a 30% plummet from 2018.

“It’s becoming very clear that if the labor market weakens at all, there’s no support from other sectors of the economy,” laments Eric Winograd, senior U.S. economist at AllianceBernstein, adding:

“If the labor market weakens, we’re really in trouble.”

You might disregard the first five words of that sentence…

Regards,

Brian Maher
Managing editor, The Daily Reckoning