The Daily Prophet: Time to Put Plunge Protection Team on Alert?

Connecting the dots in global markets.

Wall Street learned a valuable lesson Thursday: Stocks sometimes go down by meaningful amounts. OK, so it didn't turn out to be the bloodbath that everybody was worried about when the S&P 500 Index was down more than 1 percent around noon New York time before recovering more than half its losses by the close, but the weakness throughout the day was enough to remind investors that equities aren't a one-way trade higher.

The other takeaway was just how important tax cuts are to the markets. Although earnings growth has been solid, investors need to see lower corporate tax rates to help justify shares that are trading at a lofty 18 times expected 2018 earnings. What shook the markets was news that the Senate version of the Republican tax overhaul will delay until Jan. 1, 2019, the corporate rate cut to 20 percent from 35 percent. In addition, an amendment to the House version of the bill would boost proposed rates on trillions of dollars of U.S. companies’ overseas income to 14 percent on income held as cash and 7 percent on non-cash holdings, up from 12 percent and 5 percent in a bill proposed by House Ways and Means Chairman Kevin Brady a week ago.

Investors are unusually jittery these days, in part because it seems that everyone is betting the same way. Bloomberg News' Andrew Cinko recently reported that the difference between newsletter writers classified as bulls by Investors Intelligence and those marked as bears has risen to 50 percent, the biggest gap since early 1987 when it reached 50.5 percent. While that's no guarantee stocks are due for a fall anytime soon, and there's plenty of good news backing equities, it suggests that the time to be extra cautious is at hand.

The silver lining in the market turbulence is that volatility is on the rise, with the Cboe VIX Index rising the most since August. Perhaps more significantly, the gauge is now at its average for the year, according to Bloomberg News' Sarah Ponczek. There's been no shortage of handwringing over the record low levels of volatility, with many saying it was a sign of complacency. At 11.07, the gauge, which uses options-trading data to measure implied volatility of S&P 500 stocks, still sits below the bull-market average of 18.3. “In terms of how we see the world and the impact to our strategy, to the extent this reform causes some uncertainty, that could lead to a pickup in volatility,” David Jilek, the chief investment strategist at Gateway Investment Advisers, told Bloomberg News. The lack of volatility is of particular concern to central bankers, who see it as a green light for investors to take ever bigger -- and unwarranted -- risks. In fact, some strategists and investors say the main reason the Federal Reserve is raising  interest rates despite the lack of inflation is to keep the lack of volatility from causing financial instability. Fed Governor Lael Brainard said in a September speech that it’s important to remain “vigilant” for signs of bubbles in a period of low rates and sustained economic growth, “especially in areas such as commercial real estate and corporate bonds, as well as the exceptionally low levels of expected volatility.”

Another market getting hit hard is corporate debt rated below investment grade. BlackRock's $18.7 billion iShares iBoxx High Yield Corporate Bond ETF fell to its lowest level since March as the number of shares traded rose to more than five times the daily average. More broadly, investors are demanding an extra 3.9 percentage points in yields to own junk bonds rather than Treasuries, up from 3.56 percentage points just two weeks ago. The selloff came on the same day that Goldman Sachs analysts released a report noting that while U.S. aggregate credit quality has reversed deteriorating trends, "the picture under the hood remains challenging." Due to rising leverage in recent years, the "ability of U.S. non-financial corporations to withstand any potential negative shock remains greatly diminished," they added. Three of the biggest junk-rated borrowers, IHeartMedia, CenturyLink and Community Health Systems, posted disappointing earnings that sent their bonds plunging. Morgan Stanley analysts note that the House GOP tax plan would limit interest deductibility, which means that high-yield borrowers could face a higher after-tax cost of interest. That's a problem with leverage for high-yield issuers having risen to about 4.5 times from the post-crisis low of about 3.5 times in 2011. To be sure, the current selloff is similar in magnitude to what the market suffered in early August and March, and yield spreads are much lower than where they were a year ago, which was about 5 percentage points.

Europe's shared currency rose the most in three weeks against the dollar and was stronger against most major currencies except the yen and Swiss franc after the European Commission said the euro-area economy would grow at the fastest pace in a decade this year. Raising its 2017 forecast for the 19-country bloc to 2.2 percent from 1.7 percent in May, the EU’s executive arm cited “resilient private consumption,” and it predicted a 2.1 percent expansion in 2018, according to Bloomberg News' Nikos Chrysoloras and Viktoria Dendrinou. The brighter outlook was a bit of good news for euro bulls after watching the Bloomberg Euro Index drop 2 percent from its high for the year in August through Wednesday. European Central Bank Executive Board member Benoit Coeure said Thursday that the recovery is the strongest in almost two decades in terms of “robustness and balance.” After years tackling the financial crisis, the euro-area economy has racked up 18 straight quarters of growth and survey evidence points to continued solid expansion. The momentum provides further support for the currency union after a critical electoral year in which anti-EU populists were defeated in a series of key votes.

The soaring diesel market has taken a turn for the worse, and that could be bad news for traders who have amassed record bets on an extended rally in oil, according to Bloomberg News. With demand for the fuel accelerating in September after a hurricane knocked out a swath of U.S. refining and fires eliminated processing in Europe’s hub, diesel was credited with underpinning a rally in crude. Brent jumped above $60 a barrel last month and is still on an upward trajectory. But while those refinery issues issues are normalizing -- and diesel is weakening -- there’s been little let-up in the rally in crude futures, which reached a more than two-year high of $64.65 a barrel on Nov. 7, report Alex Longley, Bill Lehane and Firat Kayakiran. What happens in diesel matters for crude. The fuel is central to the pricing of other so-called distillates that also include jet fuel and heating oil, which together, account for over one third of global oil consumption, according to data from BP Plc. The net-long position in Brent crude futures and options was the equivalent of 530 million barrels last week, according to ICE Futures Europe data, with more than 10 long positions for each short.

The next stop on President Donald Trump's Asia tour is Vietnam, where he'll be Friday, Saturday and Sunday. The visit will put a spotlight on the Southeast Asian country's economy and markets. Gross domestic product is chugging along at just over a 6 percent clip, and the benchmark VN Index has gained 27.2 percent his year, better than the 18.1 percent increase in the MSCI Frontier Emerging Markets Index. The Communist Party leadership wants closer economic ties with the U.S. to boost the country's export-dependent economy and reduce its reliance on China, according to Bloomberg News' Justin Sink and Andy Sharp. China accounted for 21 percent of Vietnam’s total international trade in 2016, almost twice as much as a decade earlier, while the U.S. accounted for about 13 percent, International Monetary Fund data show. Vietnam is likely to court Trump by easing investment restrictions and signing large business deals to blunt criticism over a trade surplus with the U.S. that more than doubled in five years. When Prime Minister Nguyen Xuan Phuc visited the White House in June, Vietnam presented a bundle of such commercial deals.

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