Daily Comment (October 23, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Global equities are under pressure this morning.  Note that China’s big rally yesterday was unable to hold.  Earnings disappointments are being cited as the reason.  However, as our earnings figures show, earnings are coming in a bit higher than expected.  What is starting to affect equities is the idea that sequential earnings growth is clearly slowing.  That notion, coupled with a declining multiple, is putting pressure on stocks.  Here are the items we are watching this morning:

Day of decision: The EC has rejected Italy’s budget.  We now begin a three-week negotiation period during which Italy will be required to submit an amended budget.  If an agreement isn’t reached, the EC could implement the “Excessive Deficit Procedure.”  This process would probably continue until the end of November.  Ultimately, fines could be imposed.[1]  Although EC rules create lots of temporary deadlines that help facilitate agreements, Italy appears ready to defy the Eurozone.  In the end, we expect the EC to blink which will undermine Germany’s hold on the Eurozone and pressure the EUR lower.

Brexit grinds on: PM May has offered a four-point plan to address the Brexit issue.[2]  The most important element is that she proposes to extend the transition period to the end of 2021.  In addition, the troublesome Northern Ireland issue would be addressed by a temporary joint border control body that would prevent a hard border.  During this period of “limbo” negotiations would continue on a free trade deal.  May’s political position within the Tories remains dicey; however, she continues to survive against all odds,[3] mostly because there is no good alternative within the party.[4]  At the same time, if the government falls and elections are necessary, the Tories may find themselves out of office.  That fear has been enough to keep May in power.

Khashoggi: Turkish President Erdogan continues to pressure the Saudis, indicating today that the Saudi journalist was killed in a “savage” manner, laying out a case that comes just short of accusing the KSA of a pre-meditated murder.[5]  Although we and others have speculated that Erdogan wants financial support for his beleaguered economy and a withdrawal of funding and support for the Kurds, there is nothing in the Turkish president’s tone to suggest that he has achieved satisfactory compensation for this act that occurred within the Turkish state.  If Erdogan changes his tone, we will take it as evidence that an agreement has been reached.

Other items:Oil prices fell today after the Saudis promised to offset any loss of Iranian oil.[6]  Although we are not surprised by the announcement, “saying is one thing, but doing is another.”  Chancellor Merkel has agreed to open up Germany to U.S. LNG imports.[7]  This is an important concession by Germany, which has mostly supported piped natural gas from Russia, even supporting projects that would avoid land pipes through Ukraine.  Finally, Canada has allowed China to install underwater monitoring devices near a U.S. nuclear submarine base.[8]  We view this as a stunning and disturbing development, perhaps done by the Trudeau government in retaliation over trade tensions.  The Canadians seem to miss that their defense relies deeply on U.S. power projection.  Participating in a Chinese project that could undermine U.S. power projection is dangerous for them as well.

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[1] https://www.cnbc.com/2018/10/22/european-commission-on-italys-2019-budget—what-could-happen-next.html

[2] https://www.ft.com/content/de915670-d60d-11e8-a854-33d6f82e62f8?emailId=5bcea6664ab701000494c62b&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[3] https://www.politico.eu/article/theresa-may-only-four-steps-left-to-reach-irish-backstop-brexit-deal/?utm_source=POLITICO.EU&utm_campaign=378803a464-EMAIL_CAMPAIGN_2018_10_23_04_38&utm_medium=email&utm_term=0_10959edeb5-378803a464-190334489

[4] https://www.ft.com/content/c4f357dc-d5fd-11e8-a854-33d6f82e62f8?emailId=5bcea6664ab701000494c62b&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[5] https://www.ft.com/content/76a34b70-d6a5-11e8-ab8e-6be0dcf18713

[6] https://www.bloomberg.com/news/articles/2018-10-23/saudi-oil-chief-says-opec-s-in-produce-as-much-as-you-can-mode and https://www.reuters.com/article/us-global-oil/oil-falls-as-saudi-arabia-says-it-will-play-responsible-role-idUSKCN1MX046

[7] https://www.wsj.com/articles/in-win-for-trump-merkel-changes-course-on-u-s-gas-imports-1540209647

[8] https://www.scmp.com/news/china/society/article/2169474/canada-installs-chinese-underwater-monitoring-devices-next-us