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‘The most important chart in the world’ offers a warning sign

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Government bond yields recently held above an important level, but the next test may prove dangerous for the stock market.

The benchmark 10-year Treasury note yield tested 1.5% in late August and early September, bouncing off that level and most recently trading around 1.8%.

That’s the third time the barrier has been broken since the economic recovery began in mid-2009, with the yield bouncing up strong each time. This signaled the renewal of the longest bull market run in Wall Street history that has coincided with the most durable expansion in U.S. history.

However, another challenge could mean tough times on the horizon, according to an analysis by Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch. In his weekly analysis of market flows, Hartnett called the 10-year’s movements over the past decade, and specifically its ability to stay above the 1.5% yield level, “the most important chart in the world.”

Hartnett explained that the stock market has maintained a close relationship with bond yields that could become ominous if fixed income stages another big rally, which he expects to happen in 2020 and be a drag on stocks and other risk assets.

“For the past 10 years, the correct market mantra has been lower yields mean lower credit spreads and higher stocks, so long as lower yields prevent recession. But given 1.5% on the 10-year Treasury was not breached in 2012 & 2016 when recession fears were high, a break below in 2019 would incite fears of a recession ‘tipping point’ causing higher spreads and lower stocks,” he said in an email.

Indeed, recession fears had been elevated during much the summer, cresting when the two-year yield briefly passed above the 10-year, a phenomenon known as an inverted yield curve. Inversions have been reliable recession indicators for the past 50 years.

However, a swell of mostly positive economic data, renewed hopes for a trade deal between the U.S. and China and the long-awaited announcement of more monetary stimulus from the European Central Bank helped turn the tide for bond yields, ending the 2-year/10-year inversion and indicating that things may not be as bad as feared.

Investors have been fleeing bond funds since yields bottomed earlier this month, with $6.1 billion in outflows over the past week, the second-biggest run of redemptions on record, according to BofAML data. The move came as the 1.5% level held, which coincided with a boost in sentiment.

“Emotionally and psychologically it probably was big because of the fact that global yields are negative. If we did break to a new low in that 10-year that we haven’t seen, that could have set off talk about breaking 1%,” said Jim Paulsen, chief investment strategist at the Leuthold Group. “That could have been very risky given the fragile state of where mindsets are now with recession, and that might be just enough to freeze up the financial markets.”

However, while the BofAML strategy team is positive for risk assets in 2019, it is bearish beyond that as it expects yields to head back lower. Hartnett said in his note to clients that he sees a 2020 with a “bond bubble pop” that “induces [a] Big Top in credit (spreads trough) & equities (multiples peak), causing Wall St deleveraging & Main St recession.”

“There’s a good chance that U.S. rates are going to sell off, said Robert Tipp, chief investment strategist at PGIM Fixed Income. “Our rates are simply unsustainably high vs. the rest of the world.”

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Morgan Stanley warns tariff escalation remains a ‘meaningful risk’

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President Donald Trump meets with China’s President Xi Jinping at the start of their bilateral meeting at the G20 leaders summit in Osaka, Japan, June 29, 2019.

Kevin Lemarque | Reuters

Morgan Stanley says President Donald Trump’s partial trade deal with China is an “uncertain” arrangement at best and there does not appear to be viable path to reduce existing tariffs at the moment. 

The U.S. agreed to suspend a tariff increase on at least $250 billion in Chinese goods to 30% from 25% set for Tuesday, but a tariff hike implemented in September was not rolled back and plans for another hike just before the the Christmas holiday on Dec. 15 remain in place.

Without a durable dispute settlement mechanism in place, another round of tariff increases cannot be ruled out, 
according to Morgan Stanley. 

“There is not yet a viable path to existing tariffs declining, and tariff escalation remains a meaningful risk,” the bank said in a note. “Thus, we do not yet expect a meaningful rebound in corporate behavior that would drive global growth expectations higher.”

The president said that the first phase of the trade deal will be written over the next three weeks. As part of phase one, China will purchase between $40 billion and $50 billion in U.S. agricultural products.

Evercore wrote that the first phase of the U.S.-China trade deal doesn’t clear the air for global corporations to decide on where to invest, produce hire or source. If the U.S. maintains a “stop the China rise” mentality perspective, the trade war will continue, the firm wrote.

“Trump’s statement that ‘We are near the end of the trade war’ is not plausible to us,” Evercore wrote in a note. “We do not expect tariff cuts in 2020 – but are ready to be favorably surprised.

“And as long as such punitive tariffs remain, we would describe US-China economic relations as bad, not good.”

Goldman Sachs sees a 60% chance that the announced 15% tariffs will take effect, but expects a delay until early 2020 as opposed to the current deadline of Dec. 15. Evercore said it expects a delay and no additional tariff hikes in 2020.

In the past year, the U.S. has set tariffs on billions of dollars worth of Chinese products, and China has retaliated with its own levies, igniting concern over slower global economic growth and weaker corporate earnings.

JP Morgan said the first phase of the deal is a positive development after months of trade escalation, but that the outcome is not a surprise for the market. It expects that US-China tension could escalate again, especially during the 2020 presidential election.

“Investors had high hopes for some form of mini-deal in the weeks before the meeting, and Friday’s announcement has at least been partially, if not fully, priced in,” the firm wrote.

Macro impact of the mini deal removes some downside risk in the next quarters, but does not affect the economic slowdown trend, JP Morgan wrote. The bank’s growth forecasts are 6.2% in 2019 and 5.9% in 2020.

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Typhoon leaves as many as 33 dead, 376,000 without power in Japan

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Helicopters, boats and thousands of troops were deployed across Japan to rescue people stranded in flooded homes Sunday, as the death toll from a ferocious typhoon climbed to as high as 33. One woman fell to her death as she was being placed inside a rescue helicopter.

Typhoon Hagibis made landfall south of Tokyo on Saturday evening and battered central and northern Japan with torrents of rain and powerful gusts of wind. The typhoon was downgraded to a tropical storm on Sunday.

Public broadcaster NHK said 14 rivers across the nation had flooded, some spilling out in more than one spot.

The Tokyo Fire Department said a woman in her 70s was accidentally dropped 40 meters (131 feet) to the ground while being transported into a rescue helicopter in Iwaki city in Fukushima prefecture, a northern area devastated by the typhoon.

Department officials held a news conference to apologize, bowing deeply and long, according to Japanese custom, and acknowledged the woman had not been strapped in properly.

The government’s Fire and Disaster Management Agency, which tends to be conservative in its counts, said late Sunday that 14 people died, 11 were missing and 187 were injured as a result of the typhoon. It said 1,283 homes were flooded and 517 were damaged, partially or totally.

Japanese media tallies were higher. Kyodo News agency reported that 33 people died and 19 were missing.

“The major typhoon has caused immense damage far and wide in eastern Japan,” government spokesman Yoshihide Suga told reporters.

News footage showed a rescue helicopter hovering in a flooded area in Nagano prefecture where an embankment of the Chikuma River broke, and streams of water were continuing to spread over residential areas. The chopper plucked those stranded on the second floor of a home submerged in muddy waters.

Aerial footage showed tractors at work trying to control the flooding and several people on a rooftop, with one waving a white cloth to get the attention of a helicopter. Nearby was a child’s school bag. In another part of Nagano, rows of Japan’s prized bullet trains, parked in a facility, were sitting in a pool of water.

A section of the city of Date in Fukushima prefecture was also flooded, with only rooftops of residential homes visible in some areas, and rescuers paddled in boats to get people out. Parts of nearby Miyagi prefecture were also underwater.

The Tama River, which runs by Tokyo, overflowed its banks, flooding homes and other buildings in the area.

Among the reported deaths were those whose homes were buried in landslides. Other fatalities included people who got swept away by raging rivers.

Early Sunday, Suga said that some 376,000 homes were without electricity, and that 14,000 lacked running water.

Tokyo Electric Power Co. said late Sunday that more than 66,000 homes were still without power. Tohoku Electric Co. said 5,600 homes still lacked electricity, in the northern prefectures of Miyagi, Iwate and Fukushima. Both utilities said they were working to restore power.

Several train services in the Tokyo area resumed early in the morning, while others restarted later.

Ruling party politician Fumio Kishida said the government would do its utmost in rescue operations, including making sure that those who moved to shelters were taken care of.

He acknowledged that Japan’s power grids need to be strengthened so people in disaster areas can rely on timely information.

“So many risks remain, and it is a reality that we must stay on guard,” Kishida said on news talk show on NHK. “We must do our utmost. In these times, a disaster can hit anytime.”

The Rugby World Cup match between Namibia and Canada, scheduled for Sunday in Kamaishi, in northern Japan, was canceled as a precautionary measure, but Japan played Scotland, to a win, as scheduled Sunday evening. Matches on Saturday had been canceled. Stores and amusement parks had also closed, and some Tokyo stores remained closed Sunday.

As the typhoon bore down on Saturday with heavy rain and strong winds, the usually crowded train stations and bustling streets of Tokyo were deserted. But life was returning to normal on Sunday, and flights that had been grounded from Tokyo airports were gradually being resumed.

Evacuation centers had been set up in coastal towns, with tens of thousands seeking shelter. Kyodo News agency said evacuation warnings had been issued to more than 6 million people.

The typhoon disrupted a three-day weekend in Japan that includes Sports Day on Monday.

The authorities had repeatedly warned that Hagibis was on par with a typhoon that wreaked havoc on the Tokyo region in 1958, but the safety infrastructure that Japan’s modernization has brought was apparent. The typhoon six decades ago left more than 1,200 people dead and half a million houses flooded.

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Saudi Arabia a precedent for fixing US-Russia relations

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Russia’s President Vladimir Putin (L) and Russian Direct Investment Fund CEO Kirill Dmitriev during a meeting with Russian Direct Investment Fund experts and representatives of international investment community at Konstantin Palace.

Mikhail Klimentyev | TASS via Getty Images

The head of Russia‘s $10 billion state investment vehicle is optimistic about repairing relations with Washington, he told CNBC on Sunday, pointing to Moscow’s growing bond with Saudi Arabia as a precedent.

Russia isn’t trying to fill a void in the Middle East left by what some describe as an inward-turning America, Kirill Dimitriev, chief executive of Russia’s sovereign wealth fund (RDIF) told CNBC’s Hadley Gamble in Riyadh. He insisted that Russia’s growing investments in and trade with Saudi Arabia should be seen as “building bridges” rather than engaging the strategic competition that many in the West regularly warn about.

“Really we are not talking about, you know, the strategic partnerships that Saudi has with the U.S., and what we are doing is not against the U.S. It’s actually building something that is very positive,” Dimitriev said. “And building something that helps Saudi economy, Russian economy — and builds the friendship between our nations.”

The CEO’s comments come at a time of frigid relations between the U.S. and Russia, as the latter remains under U.S. sanctions and has been accused by the U.S. intelligence community of meddling in the 2016 election and posing a continued threat to the presidential election in 2020.

Dimitriev pointed to his country’s blossoming friendship with Saudi Arabia — something that only four years ago was in serious doubt, given the animosity between the two during the Cold War. The last few years, by contrast, have seen the creation of a historic oil production alliance led by Riyadh and Moscow, increased trade and investment, and the first state visit by a Saudi monarch to Russia.

Russian President Vladimir Putin speaks during the 16th Valdai International Discussion Club meeting in Sochi, Russia on October 3, 2019.

Anadolu Agency | Anadolu Agency | Getty Images

“I think we need to go back to basics… I’m sure the Saudi example is very interesting to try at some point to restore the relationship with the U.S., because if we could do it with Saudi Arabia in four years, why can’t we do it with the U.S. going forward?” he asked.

“Many people didn’t believe that we’ll make much progress,” Dimitriev said of the relationship with the Saudi kingdom. “And it seemed too distant because Russia and Saudi Arabia were worlds apart. We had lots of differences during Soviet times. We had lots of differences in many politics in the Middle East. But now I can report to you that we made really breakthrough and this is a breakthrough because President Putin and King Salman and now Crown Prince Mohammed bin Salman really believed that it’s possible to bring Russia and Saudi Arabia closer together.”

New Saudi-Russia investment projects

Dimitriev, as chief of RDIF, is tasked with attracting inward investment to Russia in a wide range of sectors. In previous interviews with CNBC, he has often downplayed political tensions and espoused better relations to promote trade and investment. He has criticized U.S. sanctions on Russia, calling them unproductive. He has also vocally defended Michael Calvey, the American investor currently under house arrest in Russia on state charges of defrauding a Russian bank, allegations Calvey says are untrue.

RDIF already has investment partnerships with Saudi Arabia’s sovereign wealth funds, PIF and SAGIA. Saudi Aramco has made moves to invest in Russia’s energy industry, with the two companies agreeing on terms of an investment into Russian oilfield services firm Novomet earlier this year. The two countries also jointly invest in an energy fund through a Russian partnership with Saudi state oil giant Aramco, and are expected to announce 10 new investment projects in the oil and technology spheres on Monday.

Saudi Arabia has so far invested $2.5 billion of a $10 billion investment pledge into a number of Russian sectors, including energy, infrastructure and technology.

“This angle of Middle East-Russia-Asian markets is a very interesting angle because there are lots of growth opportunities in all those markets,” Dimitriev said. “Of course the situation in the Middle East is still quite volatile and we know about geopolitical tensions but there is no doubt that there is a major opportunity to grow the Saudi economy.”

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