The Wall Street Journal - 03.09.2019

THE WALL STREET JOURNAL. ***** Tuesday, September 3, 2019 |B9

THE TICKER|Market events coming this week

Analysts expect Lululemon Athletica to report a quarterly profit of 89 cents a share on Thursday.

CAYCE CLIFFORD FOR THE WALL STREET JOURNAL

Tuesday

ISM mfg. index

July, previous 51.2

Aug., expected 51.0

Construction spending

June, previous down 1.3%

July, expected up 0.3%

Earnings expected*

Estimate/YearAgo($)

Coupa Software

-0.10/0.05

HealthEquity 0.35/0.34

Wednesday

Mort. bankers indexes

Purch., previous down 4%

Refinan., prev. down 8%

EIA status report

Previouschangein stocksin

millionsof barrels

Crude oil down 10.0

Gasoline down 2.1

Distillates down 2.1

Int’l trade deficit

June, prev. $55.15 billion

July, exp. $53.7 billion

Earnings expected*

Estimate/YearAgo($)

American Eagle

Outfitters 0.32/0.34

Copart 0.58/0.42

Palo Alto Networks

1.42/1.28

Thursday

Initial jobless claims

Previous 215,000

Expected 215,000

EIA report: natural gas

Previouschangein stocksin

billionsof cubicfeet

up 60

ISM non-mfg index

July, previous 53.7

Aug., expected 54.0

Factory orders

June, previous up 0.6%

July, expected up 0.8%

Productivity

2nd qtr. first est. up 2.3%

2nd qtr. rev. est. up 2.2%

Unit labor costs

2nd qtr. first est. up 2.4%

2nd qtr. rev. est. up 2.5%

Earnings expected*

Estimate/YearAgo($)

Ciena 0.58/0.48

Donaldson Co.0.61/0.58

Guidewire Software

0.50/0.81

Lululemon 0.89/0.71

SAIC 0.88/1.13

Friday

Nonfarm payrolls

July, previous 164,000

Aug., expected 149,000

Unemployment rate

July, previous 3.7%

Aug., expected 3.7%

* FACTSET ESTIMATES EARNINGS-PER-SHARE ESTIMATES DON’T INCLUDE EXTRAORDINARY ITEMS (LOSSES IN PARENTHESES)  ADJUSTED FOR

STOCK SPLIT NOTE: FORECASTS ARE FROM DOW JONES WEEKLY SURVEY OF ECONOMISTS

in tech.

It is meant to be a testing

ground for “registration-

based” IPOs in which compa-

nies and investors, rather than

regulators, determine the size

and timing of capital raising.

It also permits some listings

from unprofitable companies

that can’t go public on Shang-

hai’s main board.

But while the Shanghai

Stock Exchange reviews and

approves Star applications, the

regulatory panel outranks the

exchange and has the final say

on allowing companies to list.

Shen Meng, director at

Chanson & Co., a Beijing-based

boutique investment bank,

said the exchange judged in-

vestors could make their own

decisions on the company,

given sufficient disclosure, but

the regulator might have been

more concerned that compa-

nies would be encouraged to

exploit accounting loopholes.

Wang Jiyue, an author and

veteran investment banker,

said the decisions reflected

philosophical differences. “The

Shanghai Stock Exchange is

more forward-looking. The

CSRC plays by the book more

closely,” said Mr. Wang.

Since March, more than 150

companies have applied to list

on the Star market, including

software and biotechnology

firms. The securities regulator

has approved 29 applications.

—Zhou Wei

contributed to this article.

The rejection of Eversec Technology’s offering was the first for a company planning to list on the Shanghai-based Star market.

AGENCE FRANCE-PRESSE/GETTY IMAGES

China. This has intensified in-

vestor concerns about the

trust they can place in audited

financial results.

Eversec included unrealized

sales from four major con-

tracts signed in late December

in last year’s revenue and

earnings figures, but changed

how it recognized these con-

tracts after queries by the

Shanghai exchange. The com-

mission said the changes re-

vealed “weakness in basic ac-

counting work and inadequate

internal controls.”

Eversec said it respects the

decision and will further

strengthen corporate manage-

ment. Exchange officials

couldn’t be reached for com-

ment.

The new venue for home-

grown technology companies

is a pet project of President Xi

Jinping and part of Beijing’s

effort to revitalize a slowing

economy and sharpen its edge

SHANGHAI—China’s market

regulator vetoed a proposed

share listing, faulting the ac-

counting in an application that

had already been approved by

the country’s biggest stock ex-

change.

The China Securities Regu-

latory Commission said late on

Friday that it had rejected

Eversec Technology Co.’s

planned initial public offering

on the Science and Technology

Innovation Board.

This was the first such re-

fusal for the Shanghai-based

board, which is also known as

the Star market. The Nasdaq-

style board started trading in

July, with some issues tripling

or quadrupling in value on

their first day of trading.

The veto comes after an ac-

counting scandal that has dis-

rupted dozens of IPOs and

other fundraising plans in

BYSHENHONG

China Regulator

Vetoes IPO for

New Tech Board

is likely to remain fragile with

investors focused on trade war

issues,” said analysts at Italian

bank UniCredit in a note.

U.S. tariffs of 15% on Chi-

nese goods including clothing,

tools and electronics came

into force on Sunday, escalat-

ing the dispute ahead of fur-

ther talks expected later in the

month. A round of retaliatory

Chinese tariffs also took ef-

fect, targeting imports of U.S.

soybeans, crude oil and phar-

maceuticals.

Still, Chinese indexes per-

formed strongly after a pri-

vate survey of the nation’s

manufacturers showed factory

activity rebounded to a five-

MARKETS

continued contraction, though

it was modestly better than the

46.5 reading from July.

Still, investors and analysts

remained concerned about the

region’s growth prospects,

which have been buffeted by

the threat of a no-deal Brexit

and the U.S.-China trade fight.

“Growth in the eurozone

has not really recovered since

2008. It’s been pretty much in
      a zombie state,” said Christo-
      pher Peel, chief investment of-
      ficer at Tavistock Wealth in
      London, adding that Monday’s
      factory figures were unlikely
      to alter that trend.
      After the economies of Ger-
      many and the U.K. contracted
      in the second quarter, inves-
      tors were hoping that similar
      PMI surveys of those nations’
      manufacturers released Mon-
      day might offer signs the two
      economies could dodge a re-
      cession. A common definition
      of a recession is at least two
      consecutive quarters of nega-
      tive growth.
      Instead, the figures con-
      firmed that “Germany and
      others are being caught up in
      the trade war between the U.S.

and China,” said Peter Dixon,

chief economist at Commerz-

bank, adding that Germany’s

manufacturing PMI data sug-

gested the sector was likely in

recession.

The U.K. manufacturing

PMI reading—which was the

lowest in seven years—showed

the nation’s stalled departure

from the European Union

weighing on factories, Mr.

Dixon said. “The Brexit effect

is clearly there.”

Asian stock indexes were

mixed at midday Tuesday,

with Japan’s Nikkei advancing

0.08% and Hong Kong’s Hang

Seng up 0.07%. South Korea’s

Kospi fell 0.08%.

U.S. markets were closed

for the Labor Day holiday,

leading to lower-than-usual

trading volumes in Asia, said

Stephen Innes, Asia-Pacific

market strategist for Ax-

iTrader, in a note.

Investors also had to reckon

with an escalation in the U.S.-

China trade dispute after both

sides went ahead with a new

round of tariffs on each other’s

goods over the weekend.

“The general market mood

month high last month. The

private survey was in contrast

to official figures released Sat-

urday, however, which pointed

to a continuing downturn in

Chinese factories.

In the U.K., British lawmak-

ers were due to return to Par-

liament Tuesday after a sum-

mer recess. Members opposed

to a no-deal Brexit have less

than one week to table legisla-

tion that would rule it out.

“We are coming into the

week where Parliament recon-

venes and traders have had a

weekend to think about the

risks,” Mr. Dixon said.

The slide in the pound

likely drove the strong gains

for the FTSE 100, Mr. Dixon

said. A large chunk of FTSE

100 companies’ profit is gener-

ated overseas, and those earn-

ings become more valuable

with a weaker pound.

The euro hit a two-year low

against the dollar after slip-

ping last week as weak eco-

nomic data raised expectations

that the European Central

Bank would move to ease mon-

etary policy. The currency lost

0.2% against the dollar.

Global stocks rose after

manufacturing data in both

China and Europe showed some

improvement, but economic

growth concerns remained.

The Stoxx Europe 600

closed 0.3% higher on Monday,

marking a third consecutive

session of gains.

TheU.K.’sFTSE100

climbed 1%, top-

ping regional

gains as worries

the government

would turn to a general elec-

tion to break the nation’s

Brexit deadlock weighed on

the British pound. Sterling

weakened 0.7% against the

dollar. That provided a boost

to companies in the blue-chip

index that make a significant

portion of their profits over-

seas.

The broader rises in Europe

came as data showed a modest

uptick in the region’s manufac-

turing sector. The purchasing-

managers index for the euro-

zone—a gauge of activity in the

region’s factories—came in at

47.0 for August, which signaled

BYWILLHORNER

Europe Indexes Rise as Worries Linger

Indexperformance

Source: FactSet

Note: As of Sept. 2, 12 p.m. ET

2.5%

0

0.5

1.0

1.5

2.0

Aug. 30 Sept. 2

StoxxEurope600

StoxxEurope600

financialservices

MONDAY’S

MARKETS

Institutions who owned

those mortgage bonds—banks,

mortgage real-estate invest-

ment trusts and fund manag-

ers, for example—are then

pushed into buying longer-

dated Treasurys or interest-

rate swaps as the quickest and

cheapest way to replace the

income that disappeared with

the now paid-off mortgage-

backed bond.

Buying also comes from

pension funds and insurers

that sell annuities.

When yields fall, their lia-

bilities often grow faster than

their assets. That can increase

the shortfall between what

they are going to earn on their

assets and what they owe to

pensioners, also known as the

“duration gap.” To close the

Continued from page B1

gap, these businesses need

more long-term assets such as

longer-dated Treasurys.

Bets on low volatility in the

bond options and futures mar-

kets—a trade popular among

more flexible, or “uncon-

strained,” bond funds—can

also produce demand for long

dated bonds when volatility

spikes.

These trades rely on volatil-

ity and yields remaining

within a limited range. When

yields break lower, as they

have recently, investors need

to rebuild their long-term ex-

posure quickly and rush into

government bonds or related

swapmarketstodoso,says

James McAlevey, head of rates

at Aviva Investors in London.

On Wall Street, these ef-

fects all have typically obscure

sounding names: mortgage

bond owners face “negative

convexity,” the risk that the

duration of portfolios, or the

time it takes for an investor to

be paid back through coupon

payments, could grow or

shrink rapidly.

Those betting on low vola-

tility can find themselves

“short gamma,” which refers

to the risk of market losses on

short-dated options on longer-

term bonds and rate swaps.

“The lower we go in long-

term bond yields, the more de-

mand starts to increase for

certain products: gamma

hedging, convexity hedging

and closing duration gaps,”

said Mr. McAlevey. “You end

up with a market that is all

buyers and no sellers.”

None of these activities kick

off a market move, but they

can help it gather pace, said

Mr. McAlevey. Hedging activ-

ity linked to volatility strate-

gies can also create forced

sellers when yields start to

rise.

“Gamma hedging works

bothways,”hesaid.“Alotof

what’s going on is just going

to lead to higher volatility.”

The upshot is that without

these flows, the U.S. yield

curve wouldn’t have inverted

and there would be much less

chatter about a recession.

“The flattening of the

[yield] curves has been exac-

erbated by these flows,” said

Stefano Di Domizio, head of

fixed-income strategy at Abso-

lute Strategy Research.

To be sure, all this hedging

activity might have helped

yields in the U.S. and Europe

to fall more quickly to a level

where they will eventually de-

serve to be.

In “the middle of August,

it’s quiet, so moves get exag-

gerated,” says Helen Anthony,

a portfolio manager at Janus

Henderson. “We were expect-

ing this to play out over much

longer.”

Hedging

Amps Up

Bond Swing

August’s Rally Had

A Hidden Catalyst

Analysts trying to make

sense of the steep slide in bond

yields around the world in Au-

gust are pointing fingers at

many things, including slowing

global growth and a prolonged

trade fight.

Some also are attributing

yields’ push lower to a less eas-

ily explained phenomenon: hedg-

ing against “negative convexity”

in the mortgage market.

Bond prices usually rise

when interest rates fall, and fall

when rates rise. A bond with

negative convexity operates a

different way: When interest

rates fall, the price of the bond

tends to rise less than other

bonds with similar maturities.

And when rates rise, the price of

the bond tends to fall more than

other bonds with similar maturi-

ties.

Here’s why. When rates fall,

a homeowner who took out a

fixed-rate mortgage will likely try

to refinance to lock in lower

monthly payments.

That helps the consumer.

But it is a riskier game for inves-

tors in mortgage-backed securi-

ties because they are holding on

to something that is likely to be

paid off more quickly than they

initially bet.

This makes the duration of

mortgage-backed securities sen-

sitive to changes in interest

rates and gives the securities

negative convexity.

When interest rates fall, the

price of mortgage-backed securi-

ties rises less than other bonds

with similar maturities, since the

duration of time investors ex-

pect to elapse between when

the security was issued and

when it matures has shortened.

In other words, investors

need to take into account that

they might get paid a 4% rate

for only 30 weeks or 30 months

instead of 30 years.

When Treasury yields tum-

bled in August, asset managers

who invest in mortgage-backed

securities saw the duration of

their holdings drop. To compen-

sate for that, they would have

had to add duration elsewhere.

One easy way to do that

was by turning to long-dated

bonds in the Treasury market—

adding to the wave of buying

that pushed yields on the 10-

year U.S. Treasury note increas-

ingly close to its record low in

August.

—Akane Otani