Authored by Peter Tchir via Academy Securities,

It’s Either Tied in Bottom of 9th or in Extra Innings

I guess we should continue with Friday’s T-Report theme of treating the President Trump and President Xi meeting as though it was a baseball game.

From Friday

We walk in a run.  The game goes on, possibly to extra innings.  The real-world equivalent is some promise by China to reduce the trade deficit, us putting on hold any new or increased tariffs and both sides agreeing that Intellectual Property rights are important and that both sides agree to focus on…

This is my highest probability scenario. 

As far as I can tell from the press coverage I’ve seen

  • China agreed to buy more agricultural and commodity goods (as we’ve been suggesting all along is part of the ‘easy’ deal)

  • We agreed not to go ahead with the scheduled tariff increases (which were hurting us as well)

  • Both sides have agreed to talk more with what seems like a 90 day target for progress (though a timeline that could easily be extended again)

Is this ‘Deal’ Good Enough for Markets?

It seems like this should be good enough for markets to continue with the rally that took S&P 500 and Nasdaq up 4.9% and 5.6% respectively on the week.

I think the outcome is marginally better than what people were pricing in and took some of the disaster scenarios off the table.

I would expect VIX to collapse now that the biggest wildcard is either off the table or at least postponed.  (Brexit and Italy while moving Europe around seem to have lost their ability to whip U.S. markets back and forth – for now).  We have Mueller and the change in the House in January to deal with on the domestic front – but that seems to be a few weeks away, which in this choppy market, can seem like a lifetime.

The biggest driver could be the market’s view, which we share, that Powell is trying to walk back a little on the dogmatically hawkish side (though part of this apparent change makes perfect sense for a data dependent Fed that is seeing the data weaken).

Corporate bonds were noticeably weak and an outlier on Friday.  Despite the S&P 500 and Nasdaq both gaining about 0.8%, the CDX IG index was a ½ bp wider on the day, high yield was down roughly a ¼% depending on whether you looked at CDX HY or the big HY ETFs.  The leveraged loan market bounced a little (at least BKLN did) but floating rate IG corporate bonds continued to trade poorly. 

The Bloomberg Corporate bond OAS moved out 2 on Friday to 137 (from 109 in the middle of October), and it probably understates the weakness as the bond indices tend to lag their traded Beta counterparts when tracking moves to the downside (for example, corp bond spreads widened according to the index on Wednesday while CDX IG gapped 5 bps tighter and even the often ignored LQDH rallied). 

If VIX can come down and the new issue calendar can show signs of slowing into year-end, credit should be able to turn around – but since its weakness on Friday was noteworthy, across the board, we will be watching that closely.

Bottom Line

Assuming the reporting we have seen so far is accurate, this deal, coupled with some oversold technicals and generally favorable seasonality, I’d expect a moderate risk-on move to begin.  

But, since I am already trying to think about what could derail this move, and when to start cutting back on risk again, I think the rally won’t be as big or long lasting as I’d like to see.

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