We could have shown many other macro models forecasting recessions and they would on average show around 10% probability for a US recession in 2019. Now, if we look at models only using market input the probability would be closer to 25-30% indicating an interesting discrepancy. Market action is implying greater risks than what current macro data suggest when modelled against previous recessions.
If the market is overshooting against the true probability then there will likely be an interesting rebound opportunity in equities very soon. On the other hand, the macro models may be facing a false negative (i.e. not indicating a recession but it happens in 2019). This is the ugly truth about predicting the future. We can never be too sure about the outcome. For our part the 2,600 level in S&P 500 futures is important and if taken out could drive significant selling pressure short-term. Also worth noting is that liquidity is currently low in the US equity futures so large selling pressure could have some non-linear effects during a single session.
The detention of Huawei’s CFO takes conflict to new level
Ten days ago when Canadian law enforcement agents arrested Huawei’s CFO the US-China conflict was catapulted into a new level. One thing is carrying out policies against specific companies (ZTE) but another thing is to go after individuals. It raises the question whether we could see American technology executives being arrested in China. In her recent NY Times opinion piece, Kara Swisher (one of the best connected journalist in Silicon Valley) explains that this is indeed possible given the conversations she has had with Silicon Valley executives. But more importantly, she suggests that the US and China is battling for 5G network power and so far Huawei has been a winner, seeing its revenue and influence grow around the world while US-based Cisco seems to be forever stuck in the mud.
Adding to the ongoing conflict, the Bureau of Industry and Security in the US will soon release a review of controls for certain emerging technologies and it seems biotechnology partnerships between US and Chinese companies will end, also likely impacting the number of Chinese students who can study in the US.
Outside the Huawei case, a Chinese scientist, Zhang Shoucheng of Stanford University, died on 1 December (same day as the arrest of the Huawei CFO) with no official statement as to the cause. But it worth noting that his $400 million venture capital fund, Danhua Capital, is under investigation by the Office of US Trade Representative (USTR) as the agency is cracking down on what the US government sees as a Chinese infiltration of Silicon Valley.
Between 2015 and 2017 around 13% of venture capital deals had Chinese investors as participants. According to the USTR, China has deployed a new tactic in “technology transfer” since 2014 by subsidising so-called “guidance funds”, or state-backed funds if you will, that are incorporated as venture capital or private equity funds that then invest in many US technology startups. These revelations just add another layer to the complex relationship between the US and China. No matter the outcome on trade the technology battle will go on for decades.
Learn the word leveraged loans now
If you have forgotten the word leveraged loans then please take note. This special segment of the credit market took center stage during the Great Financial Crisis and now it seems that cracks are emerging in both the US and Europe in this market again. As our fixed-income specialist Althea Spinozzi highlighted last week on one of our morning calls, bids in the leveraged loan market in Europe are drying up as credit investors are getting nervous.
Recently, the companies Vue and Hurtigruten had to cancel their loan offerings in the this market due to investors pulling out of the deals. The price index on European leveraged loans (see chart) is still screaming "red alert" but the price action in the market is telling us that the high yield credit market is getting shaky and this market is often a good leading indicators of other financial markets. But the recent nervousness is not only a European phenomenon. In the US signs of weakness are also showing and Moody’s recently said that it sees similarities in the US leveraged loan market with those signs observed before the financial crisis started.