No Man’s Land

Stock market indexes are waffling without conviction this morning. With earnings season nearly finished and key inflation reports in the rear-view mirror, we’re sort of in no-man’s-land waiting for a catalyst to either resume the rally or confirm a correction. As always, traders are wary of what the Fed may do next. Bonds are selling off again as yields head higher. Traders are focused on the 10-year Treasury yield, which just climbed to 4.3%, the highest since late 2007. Does this move have any serious implications for the future? Do higher long-term yields signal the expectation that growth and inflation will run higher than the Fed would like? Or do they signal fear that federal budget deficits are getting out of control? Or are yields simply returning to more normal levels after having spent too much time near zero?

Cisco Systems (CSCO) reported 16% revenue growth and 37% earnings-per-share growth in the most recent quarter. Profit margins also topped estimates and product orders surged 30%. But while that’s great news, management’s financial guidance for the coming 12 months implies decelerating growth. The industry is finally moving beyond last year’s component shortages, and Cisco is now caught up with backlogged orders. Apparently, there is no more pent-up demand for networking equipment. That’s bad news, but it’s probably a temporary setback. Management highlighted its efforts to build the software & services business, which is far less cyclical than the hardware business. The AI trend should help boost this transition. The stock is up 4% today.

CVS Health (CVS) fell 9% in early trading after Blue Shield of California said it plans to drop CVS Caremark as its pharmacy benefit manager (PBM).
Pharmacy benefit management is a curious and very opaque business. Various and changing rebates and hidden fees make it difficult to know what drugs actually cost. And yet, PBMs provide useful services, such as negotiating drug prices on behalf of corporate healthcare plans, and handling mail-order pharmacy. Blue Shield thinks it can save 10-15% by dropping CVS and instead hiring an array of smaller companies to handle each service discretely. For example, Amazon Pharmacy will be handling mail-order, Mark Cuban Cost Plug Drug Co will manage low-cost pharmaceuticals, and CVS will still handle specialty drugs. Upending the established way pharmaceuticals are distributed won’t be easy though. This transition—if it works—will take a long time to ramp up.

Weaker economic data and a couple of high profile corporate debt defaults are beginning to really worry investors in China. Fitch Ratings, concerned with over-indebted companies and municipalities, just warned that it may cut China’s A+ credit rating. The Yuan has fallen to a 16-year low and the Chinese government has gone into damage control mode. According to Bloomberg News, authorities asked some large investment funds to refrain from selling more equities than they are buying. In addition, they’re trying to stop the flow of negative news. For example, they quit publishing the youth unemployment rate, which is over 20%. The Wall Street Journal writes, “Domestic law firms have been told by securities regulators to censor negative language about China from investor disclosures. Rather than discuss ‘adverse changes’ in the economy, companies are to describe it as ‘evolving.’ The Orwellian wordplay would be comically Communist if it didn’t bespeak a government-wide campaign to limit access to material economic information.”

The heart of the problem in China is fear of what economists call a “negative feedback loop.” In this case falling property values create problems for real estate developers, which spill over to real estate lenders. Banks and financing companies, afraid of bad loans, pull back on lending or demand higher interest rates. This, in turn, restrains growth and causes property values to fall even farther. All of this sound ominous, but how bad is it over there? We’re not sure since the quality of information is poor. Panic doesn’t seem to be present, however, judging by China’s stock market or commodity prices such as gold & oil.