THIRD QUARTER, 2019 “WHAT’S THE DEAL?”€¦ · negotiating his Brexit deal with European Union officials. Central banks became more dovish as it became ... and GM entered tense

NCM Macro

THIRD QUARTER, 2019“WHAT’S THE DEAL?”

The second half of 2019 has apparently become a live-action remake of the Art of the Deal. The US signed an agreement with Japan, has a deal pending Congressional ratification with Mexico and Canada, and continued to move backward and forward on a deal with China. Meanwhile, across the pond, Boris Johnson was negotiating his Brexit deal with European Union officials. Central banks became more dovish as it became clearer fiscal policy was not going to help stimulate a decelerating economy.

On other fronts, opioid makers are negotiating settlement deals with the authorities, Altria and Philip Morris talked about making a deal, and GM entered tense negotiations with the UAW for a new labor contract.

Impatient investors begged to know what the deals would like because the tensions began to “wreak havoc” on confidence within certain sectors of the economy.

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NCM Macro

Contents

I. “Central Planners Gonna Centrally Plan” – 3Q19 in Review➢ The No-Confidence Men: Boris Johnson and Donald Trump

➢ The Fed and QE4

II. “The Impact on Growth” – Confidence and the economy

➢ Sentiment➢ Employment and Economic Growth

III. “Escape from Negativity” – Events that could improve sentiment➢ Our Top 6 Upside Catalysts

IV. Conclusion➢ Predictions

Introduction CatalystsConfidence3Q19 Review Conclusion

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NCM Macro

I. 3Q19 in Review

“Like some slumbering

giant we are going to rise

and ping off the guy ropes

of self doubt and

negativity.”

-Boris Johnson

UK Prime Minister


Paradoxically, the more politicians talk about confidence, the more the very lack of it becomes apparent to regular people.

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NCM Macro

July 1 –President

Trump crosses the

demilitarized zone into

North Korea

July 9 –Financier

Jeffrey Epstein

indicted on Federal

sex-trafficking charges

July 13 – FTC approves

$5B settlement

with Facebook on privacy

issues

July 24 –Justice

Department opens

broad new antitrust

review of Big Tech

companies

July 24 –Boris

Johnson becomes

Prime Minister of the United Kingdom

July 30 –Capital

One reports data

breach

July 31 –Fed cuts

rates from 2.25% to

2.00%


In a significant move, the Fed cut short-term rates in July from a range of 2.25-2.50% to a range of 2.00-2.25%. This was partially seen as a reversal of the bad rate hike decision in December and an admission that the economy was showing signs of weakening.

We were surprised that the Fed hiked rates in December but we did not foresee (at the time) that they would be cutting rates so quickly (see 4Q18 NCM Macro, slide 25).

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NCM MacroAugust 5 –

Hong Kong

protests result in

>200 cancelled

flights

August 5 –Mass

shootings in El Paso

and Dayton

August 6 – US labels China

currency manipulator

August 14 –DJIA drops 800pts as

yield curve inverts,

recession fears

August 14 –US delays

tariff increases on $300b Chinese

product to 12/15

August 23 –China

promises retaliatory tariffs, US promises response, DJIA drops

623pts

August 27 – Philip

Morris and Altria

explore remerger


August saw tensions with China ratchet up once again. China was busy fighting a two-front war (Hong Kong and US trade) and, like a caged tiger, began to lash out aggressively when the US exerted more and more economic pressure on them.

Meanwhile, tensions at the polls resulted in more uncertain US economic policy. Tariff increases tended to be pushed off as markets weakened.

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NCM Macro

Sept 2 –Hurricane

Dorian hits

Bahamas

Sept 4 –Carrie Lam withdraws

Hong Kong extradition

bill

Sept 9 –Johnson

vows to exit EU on 10/31

even without deal

Sept 10 –John

Bolton dismissed

as nat’lsecurity advisor

Sept 10 –Apple

introduces iPhone 11 and Apple

TV

Sept 12 –ECB cuts

rates, unveils new QE program TLTRO III

Sept 14 –Saudi oil

production hit after

attacks on facilities


September saw tensions flare up across more diverse geographies. Boris Johnson, the Prime Minister of the UK, was not backing down from Brexit. The ECB, afraid of rising tensions and slowing growth, enacted even more dovish monetary policy.

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Sept 15 –UAW

workers at GM go on

strike

Sept 18 – Fed cuts rates

from 2.00% to 1.75%

Sept 21 –Trump says would not

accept partial

accord with China

Sept 21 –Whistleblower says “Trump repeatedly

pressed Ukraine to investigate

Biden’s son”

Sept 25 – Pelosi to move ahead

with official impeachment

inquiry

Sept 30 –Forever 21 files for bankruptcy


The end of September saw the Fed cut interest rates again. But the biggest story was a renewed push by Congressional Democrats aimed at impeaching the President. Although at the time (and even now) the firm evidence, beyond hearsay, remains circumspect, now that the Democrats are so firmly committed it is difficult to see them backing down.

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NCM Macro

Oct 1 –Schwab

cuts brokerage

fees to zero

Oct 1 –Hong Kong teen

protestor killed by police

Oct 1 – ISM Manufacturing Index slumps (47.8 vs. est.

50.0). Exports, employment very weak

Oct 3 – ISM Services

disappoints (52.6 vs. est.

55.0)

Oct 4 – Fed conducts

emergency video

conference in private

Oct 9 – Fed announces purchases of short-

term bonds

Oct 11 –US &

China agree to “Phase

1” skinny deal


Early October saw the culmination of what headlines had been pointing to for quite some time. High-frequency economic data dramatically disappointed, the Fed acted to bail out rising tensions in short-term funding markets, the US and China kicked the tariff can down the road a little further and retail brokerages in the United States cut commissions to zero.

In some ways, this “feels” like the end of December, when Secretary of Treasury Mnuchin tweeted “[CEOs] have ample liquidity” and the ECB moved to friendlier monetary policy.

At the end of the day, most politicians recognize that the economy (and markets) is, over the short term, a confidence game. People who are interested in the economy performing well will ultimately act to solidify confidence; people who are interested in the economy performing poorly tend to act to undermine confidence. This phenomenon is generally apolitical.

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NCM MacroThe Core Issue in China – Slowing Potential Growth, Y = A + K + L


The Chinese population continues to grow at just 0.5% per year. And that has slowed even further. On its Q3 Earnings Call on October 16, Abbott Labs’ CEO Miles White noted that his Pediatric Nutrition business disappointed in China due to “historically low birth rates.”

When growth is slowing, it can become pernicious. This is a primary reason China is trying like mad to exert as much as it can from trade. There is only so much juice in the orange and it’s up to the Politburo to squeeze out the incremental drops. But the fruit is increasingly dry.

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NCM MacroFlashback: Will We Get an Infrastructure Bill?


As we noted at the beginning of the year, a real infrastructure bill was becoming less and less likely. Nevertheless, fiscal policy would need to improve in order to take the baton from a more constrictive monetary policy.

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NCM MacroAnswer: No


With prospects for impeachment looming, a substantial infrastructure bill hasn’t seemed further away for quite some time. The lack of fiscal policy support is one reason monetary policy (the Federal Reserve) is providing a more accommodative backdrop.

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NCM MacroMonetary Policy Becoming Friendlier


Shown graphically is the market for Fed Funds Futures, the short term interest rate in the US.

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NCM MacroAnd More Interest Rate Cuts are Likely


This time last year, the consensus was that the Fed would be hiking rates for quite some time. Now, the market thinks the Fed will cut rates twice more before September 2020.

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NCM Macro

II. Why People are Scared

“America was not built on

fear. America was built on

courage, on imagination

and an unbeatable

determination to do the

job at hand.”

-Harry Truman


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NCM MacroWhat CEOs are Saying in Quarterly Reports

➢ Jamie Dimon, JPMorgan Chase CEO: Marginal investment is being impacted by trade fatigue in terms of the uncertain while it’s slower growth it’s still growth. In the US, the

consumer is incredibly strong...Credit is good.

➢ Robert Knight, Union Pacific CFO: As I look to 2020, the variable is really the economy. As

we sit here today, we’re certainly hopeful and thinking that the volume will be on the maybe a slightly on the positive side of the ledge, but that’s still an unknown at this point.

➢ Kenny Rocker, Union Pacific CMO: I think the economy will help us out with the housing market. Right now, it’s been pretty flat. We’d expect both the petrochem and the construction business to continue to grow


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NCM MacroWhat CEOs are Saying in Quarterly Reports

➢ Jim Foote, CSX CEO: These consumer driven sides of the economy are all doing so well. And we saw very early in the year the industrial economy was separating and was not

performing very well at all….The consumer economy is still doing relatively well.

➢ Sanjay Mehrotra, Micron CEO: While the demand recovery in DRAM and NAND

[memory chips] is encouraging, we remain mindful of ongoing macroeconomic and trade uncertainties.

➢ Jim Foote, CSX CEO: Freight demand is generally in line with expectations set out at the end of last quarter when we adjusted to reflect what was a realistic view of softer underlying economic activity. Nothing in the industrial economy has really changed

since then.


Hope remains: the shining light is the persistent positive trend from the Consumer side of the economy. But the Manufacturing side is increasingly uncertain.

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NCM MacroISM Manufacturing Sector (brown) vs. Non-Manufacturing Sector (green)


The divergence between the two sides of the economy really began in December 2018 with the last Fed rate hike and a ratchet up in trade wars. Although the Services side of the economy has softened, it hasn’t softened near the degree of the Manufacturing side.

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NCM MacroManufacturing Example (Autos – US Sales, annualized, millions)


Manufacturing weakness has been seen on a number of fronts. Autos and airplanes are the primary places.

On the auto side of the economy, sales in the US haven’t grown since 2015. We are replacing vehicles but we aren’t buying additional vehicles.

In addition, GM and the UAW are currently still in the process of tense negotiations that could hurt profitability even more. In fact, the latest proposed deal agrees to the following:• Most union members would receive a $11,000 “ratification” bonus upon signing the contract;• 3% wage increases in years 2 and 4;• 4% lump sum bonuses in years 1 and 3;• Maintain existing health insurance coverage;• GM is allowed to close 3 plants (these plants have already been idled).

Of course, the wage increases should be positive for the economy. The plant closures are not.

Source: CNBC (https://www.cnbc.com/2019/10/17/gm-deal-with-uaw-includes-closing-three-us-plants-11000-ratification-bonuses.html)

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NCM MacroManufacturing Example (Planes)

500

550

600

650

700

750

800

850

Boeing Commercial Aircraft Deliveries (last 12 months, units)


One of the main drivers of weakness in manufacturing has been the profound fall in Boeing’s aircraft deliveries. This is big business and Boeing has dramatically slowed its build rate in response to regulatory scrutiny over the 737 MAX. This is unlikely to resolve until sometime in the first quarter of 2020.

Boeing’s supply chain is vast so a slower build rate has reverberations across a host of industries, from fastener companies to avionics suppliers.

Notably, Boeing still has 5,705 units in its backlog, which means that when and if they get back to the former operating rate, they will still have roughly 7 years of backlog to work against. Importantly, although the company has seen its order rate understandably slow down since the 737 MAX issues came to light, they have not seen material order cancellations.

The bottom line here is that Boeing is having an impact on manufacturing in the US. We obviously can’t pin all manufacturing woes on one company, but it is also important not to underestimate the noise events like this can have on short-term, high-frequency economic data.

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NCM MacroManufacturing Example (Chicago Capital Spending Expectations)


Again, last December appeared to mark a turning point in expectations for Manufacturing. The uncertainty spawned by trade negotiations has seen capital spending forecasts drop to their lowest levels in years. Note, again, that Chicago is geographically tied to Boeing.

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NCM MacroManufacturing Example (GM and F stock)


Although the S&P 500 has rallied impressively (+40% and change) since the end of 2016, auto manufacturers have not participated in this rally as much. This is the result of flat-lining US sales and weakness in China, where both Ford and General Motors have significant joint venture operations.

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NCM MacroManufacturing Example (Caterpillar stock)


Caterpillar stock shows the divergence between Manufacturing and everything else, beginning in December 2018

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NCM MacroBlended Example (New One Family Houses Sold Annualized, thousands)


On the other hand, housing – which falls in between the Consumption and Manufacturing sides of the economy – has actually picked up. This has occurred coincident with a fall in interest rates. It suggests that the Fed may have had more of an impact on the housing market than they would care to admit.

It is especially interesting that the housing market has picked up even as the Manufacturing side of the economy has slipped.

With the Fed now cutting rates once again, perhaps housing can continue to perform well.

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NCM MacroConsumer Example (Adjusted Retail Sales less Food & Auto Y/y, seasonally adjusted)


The Consumer, like Manufacturing, dipped sharply in December 2018. However, unlike manufacturing, it has had a sustained rebound. Adjusted retail sales is posting strong, if not spectacular, growth.

Also, if you look closely you can see the impact Hurricane Dorian had on retail sales in August and September. When Dorian was about to hit the Bahamas over Labor Day weekend, consumers in danger zones bought products ahead of the storm. This pulled forward consumption from September to August.

One could argue that this impacted an isolated part of the country over a short period of time. But when we are dealing with percentages of percentages and extrapolating trends, sometimes these events have impacts. It also serves as a reminder that when looking at noisy data, it is dangerous to make too much of a single data point.

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NCM MacroConsumer Example (Employment to Population Ratio)


The fundamentals for the Consumer are strong. A greater percentage of the United States population is working than at any point since the financial crisis Interestingly, note that this ratio hardly skipped a beat despite the crisis of confidence that has apparently infected the Manufacturing side.

The employment to population ratio is a different measure of employment than the traditional U-3 employment. The ratio shown here also takes into account the participation rate in the US economy.

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NCM MacroConsumer Example (Wage Growth)

1.5

2.0

2.5

3.0

3.5

4.0

Wage Growth Moving Average (FRB of Atlanta)


Wage growth has hardly skipped a beat.

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NCM MacroConsumer Example (Target and Walmart Stock)


And, unlike Caterpillar, Target and Walmart shares have appreciated dramatically.

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NCM Macro

In the midst of such a strong consumer….

Why isn’t there more business investment?


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NCM MacroSeptember ISM Manufacturing Report, Beige Book

➢ “Business outlook remains cautious. Orders seem to be decreasing, but luckily not as sharp of a decrease as we were expecting.” (Transportation Equipment)

➢ “We have seen a reduction in sales orders and, therefore, a lower demand for products we order. We have also reduced our workforce by 10 percent.” (Plastics & Rubber

Products)

➢ “Economy seems to be softening. The tariffs have caused much confusion in the

industry.” (Electrical Equipment, Appliances & Components)

➢ Manufacturing activity continued to edge lower. Contacts in some Districts suggested

that persistent trade tensions and slower global growth weighed on activity. The early impact of a recent auto strike was limited. Freight shipments stabilized after falling during the previous reporting period. (Beige Book)


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NCM Macro

➢ “Business continues to pick up as we quickly approach Q4. Week by week, we inch closer to a much-anticipated holiday retail season, which requires not only last-minute

buys, but a push to fill open positions.” (Retail Trade)

➢ “As employee cost [wages] are increasing in this better economy, it is getting harder to

fight price increases on goods and services.” (Information)

➢ “Tariffs are adding uncertainty to short-term pricing on certain commodities, but suppliers

are finding alternate solutions. The bigger impacts appear to be on demand side, which is driving short-term favorability in certain domestic markets.” (Accommodation & Food Services)

➢ Reports from Districts representing states in the southern and western U.S. generally were more upbeat than Districts representing the Midwest and Great Plains. (Beige Book)

September ISM Services Report, Beige Book


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NCM MacroGeneral Caution, Fears of Recession

MarketWatch.com penned the headline

above based on the data to the right. Clickbait may not cause recession, but it’s headlines like these that cause people to worry.

Our Take? The Facts are true, the News is Fake


One of my M&A contacts works at a respected $1.5 billion multinational company. His entire job is to look for acquisitions and perform due diligence. Management is anticipating a recession so my contact has been told not to look for acquisitions right now.

Consumers, also, are being told to prepare for recession, in part due to deceptive articles like this.

https://www.marketwatch.com/story/two-thirds-of-households-preparing-for-recession-even-as-us-economy-continues-to-grow-2019-10-16?siteid=rss&rss=1

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Merrill Lynch Fund Manager Survey, October 15

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➢ Cash levels up to 5.0% from 4.7%, leaving BofAML Bull & Bear Indicator at an “extreme bear” level of 1.3

➢ Record 9/10 say it’s “late-cycle”

➢ Record number say “fiscal policy is too restrictive


Merrill Lynch Fund Manager Survey, October 15

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NCM MacroGeneral Caution, Fears of Recession (Chief Executive Magazine)


https://chiefexecutive.net/u-s-ceos-dont-expect-a-recession-anytime-soon/

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NCM MacroGeneral Caution, CFOs Fear Recession, but CEO Survey Suggests Growth in 2020

➢ CFOs are more pessimistic than CEOs

➢ More than half (53%) of US CFOs believe that the US will be in recession by the 3rd

quarter of 2020 and 67% believe that a recession will have begun by the end of 2020.

➢ Duke CFO Survey


https://chiefexecutive.net/u-s-ceos-dont-expect-a-recession-anytime-soon/https://www.cfosurvey.org/wp-content/uploads/2019/09/2019-Q3-US-Key-Numbers-1.pdf

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The Narrative

➢ Tariff and trade uncertainty

➢ Media-

induced fear

➢ Technology

cycle

➢ Run inventory hand-to-

mouth

➢ Pull back on investment

(capex, A&M, R&D)

➢ Buy “safe

haven” assets

➢ Ebb in the macro cycle

➢ Fear of

repeating the mistakes

of 2008

➢ China slowdown

➢ Exacerbate weaker GDP growth

➢ Market

volatility

➢ Even while end

demand remains

solid

NCM Macro


This slide summarizes our view of “What’s Going On”. Note that end demand remains solid, in our view. The problems are occurring as you get higher up the supply chain.

We introduced this slide in the second quarter and it remains applicable today.

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NCM MacroQ3 Economic Volatility

Manufacturing in a bad place

➢ Trade concerns are having an impact and wreaking havoc with supply chains➢ Auto strikes, Boeing 737 MAX problems, Global growth hurting exports and

manufacturing

Consumer in a good place

➢ Retail and home sales have picked up➢ Healthy consumer credit quality, wages and employment

Uncertainty breeding volatility

➢ Fund Managers➢ Management Teams


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NCM Macro

III. Top 6 Sentiment-Driving Catalysts

“So you’re saying there’s

a chance…”

-Lloyd Christmas

Dumb and Dumber


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NCM Macro1. 737 Max get back in the air and Boeing ramps production

➢ Likelihood: Q1 2020➢ Impact: Modest


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NCM Macro2. The UAW goes back to work

➢ Likelihood: Q4 2019➢ Impact: Modest


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NCM Macro3. China trade tensions taper

➢ Likelihood: Drawn-out, Q4 2019 – Q1 2021➢ Impact: Significant


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NCM Macro4. Domestic political infighting reduces

➢ Likelihood: Q1 2021➢ Impact: Moderate


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NCM Macro5. Brexit certainty

➢ Likelihood: October 2019, with after-effects felt through mid-2020➢ Impact: Moderate


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NCM Macro6. Monetary Policy becomes less restrictive

➢ Likelihood: Ongoing➢ Impact: Moderate


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NCM Macro

IV. Conclusion

➢ Manufacturing has fallen off significantly

➢ The American people remain strong economically, if fractured

politically

➢ There are upside catalysts, but the probabilities are highly uncertain

and, in some cases, highly unlikely

-Narwhal Capital Management


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NCM Macro Outlook

QUESTIONS?

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NCM Macro

We certify that the opinions and predictions set forth in Narwhal Capital Management publications are, for better or worse, our professional

beliefs at the time of publication.

We are not under duress or pressure from any of the corporate entities mentioned, nor do we intend to do business with them on the

investment banking or advisory side of things. Nor is this a solicitation or inducement to take action, whether buying or selling, based upon the opinions presented. Again, this publication is a summarization of our professional beliefs and actions that have occurred in the past. We are

not “selling” nor attempting to convince the reader of any one particular course of action.

Although we are investment advisors, our publications are not to be construed as investment advice. Quite frankly, this publication is a

snapshot of our research and opinions. We strive to be as impartial, insightful and accurate as possible. We do base our opinions, analysis, and calculations on information and analysis that we believe to be reliable, but we cannot guarantee that they are either accurate or complete.

We may change our minds about any item mentioned and we will not necessarily update them in print. We can guarantee that our research and opinions will sometimes be flat out wrong. This may be from subjective blind spots, mistakes, ignorance, uncertainty of predicting events,

or emotional bias. However, we prefer that our predictions/opinions/research be proven right 100% of the time, and that the stocks our clients

own go up, not down, therefore you can assume some level of self-interest and “hope” is present in this and all future publications.

At the time of publication employees of Narwhal Capital Management may or may not have held positions in the securities detailed in this report.

Unless otherwise noted, all financial data for investments accessed via the Bloomberg Terminal.

Finally, we must disclose that PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS.

Conclusion

Disclosure

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NCM MacroBonus: Our View of the China “deal”

Both sides want a deal, neither wants to give much

The “skinny” deal:

➢ The US will not move forward with planned tariff increases (25%, up to 30%, on $250b)➢ The US still plans to move forward on a separate hike from 15% to 25% on $160b on

December 15➢ China promises to purchase $40-$50b worth of agricultural goods (up, according to the

President, from $10b-$15b currently)➢ Also covers aspects of currency and intellectual property (details, undisclosed)

Logistics:

➢ 4-5 weeks to get the deal in writing➢ “There was a lot of friction between the US and China and now it’s a lovefest.” – President

Trump

Bottom Line: This is a Deal to Make a Deal


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Documents

THIRD QUARTER, 2019 “WHAT’S THE DEAL?”€¦ · negotiating his Brexit deal with European Union officials. Central banks became more dovish as it became ... and GM entered tense