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Joshua Roberts | Reuters

The threat of the U.S.-China trade war escalating into something beyond nasty rhetoric and modestly effective  tariffs for the most part has been dismissed by market participants and economists.

But the idea that the dispute could turn into something more is starting to become reality.

Tuesday’s relief rally on Wall Street notwithstanding, several under-the-radar indicators are pointing to the danger that a prolonged conflict could put a serious dent into the economy of both nations, and reverberate through a global picture that at best looks tenuous.

Whether it’s increased expectations for interest rate cuts, decreasing expectations for inflation or queasy bond and stock market investors who are more aggressively pricing in slower growth, the message is being sent to the U.S. and China that danger lurks.

“The bottom line here is pretty simple if not altogether positive: markets are signaling that both the US and China have blundered into a minefield,” Nicholas Colas, co-founder of DataTrek Research, said in a note Tuesday. “The risk of a US recession is rising, sharply and quickly.”

Colas points to the various indicators on inflation, rates and concerns over the Chinese dumping U.S. Treasurys as indicators from the markets that the two sides should heed, much the same way as the Fed took cues that it was making a policy mistake by continuing to raise interest rates.

“When markets signaled to [Fed] Chair [Jerome] Powell that he was on the brink of a policy mistake, he changed course. American and Chinese negotiators could learn from that,” Colas wrote.

There is an assortment of concern pointing toward tougher times ahead:

  • The New York Fed’s gauge of recession probability over the next 12 months is now at 27.5%, easily the highest since the financial crisis.
  • The Citi Economic Surprise Index, which measures actual data readings vs. expectations, just recently bounced off its lowest reading in nearly two years and remains well in negative territory.
  • Inflation expectations are dimming as well, with the spread between the 5-year Treasury note and the 5-year Treasury Inflation Protected Security — known as the “breakeven” — pointing to 1.75% inflation, below the Fed’s desired 2% level.
  • Investors continue to reprice Fed rate actions, with a nearly 50% chance now assigned to a September cut and a 29% probability of two quarter-point reductions before the end of 2019, according to the CME. The change intimates a loss of confidence in growth and expectations that the central bank will have to step in and ease policy. Though Minneapolis Fed President Neel Kashkari told CNBC on Monday that he doesn’t see a change in policy ahead, the market feels differently.

The developments come against an otherwise positive economic backdrop.

Unemployment is at a 50-year low, GDP rose 3.2% in the first quarter and small business confidence rose again in April, according to the National Federation of Independent Business survey released Tuesday that showed its index rising 1.7 points to 103.5.

Kashkari also said he sees the U.S. in a more advantageous position than China in the trade battle.

‘It’s like lighting a match’

Still, the NFIB survey came before the latest round of trade headlines. Market reaction showed that the ecosystem around the economy and the trade headlines remains fragile.

“The economic backdrop is still positive, the market is still up year to date. But the concern now is that this takes on a life of its own,” said Quincy Krosby, chief market strategist at Prudential Financial. “It’s like lighting a match. You think you know how to control it. That’s where the uncertainty comes in.”

During a scrum with reporters Tuesday, President Donald Trump called the situation with China “a little squabble” and said his relationship with President Xi Jinping remains “extraordinary.” Stocks rallied strongly after Monday’s aggressive sell-off.

But the rhetoric in the trade war has seesawed between confrontational and adversarial, and markets are beginning to focus on the possibility of a negative outcome.

“What happens is once you start to escalate the verbiage and make it personal, and this is true in actual wars and is true in trade wars, then the uncertainty intensifies,” Krosby said.

Investors are “moving into a more defensive posture” as the negotiations drag on, with allocations likely to stay that way until there is greater clarity, she added.

“Just like in war, you’re looking for escalation or whether or not it can be defused, and then you sit down at the negotiating table,” Krosby said. “Investors are waiting for something more concrete and viable, and it may take time.”

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Analysts are bullish on Facebook’s Tuesday crypto launch

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Facebook CEO Mark Zuckerberg makes his keynote speech during Facebook Inc’s annual F8 developers conference in San Jose, California, U.S., April 30, 2019.

Stephen Lam | Reuters

Wall Street analysts are eagerly anticipating Facebook’s possible unveil of its long awaited cryptocurrency payments plan on Tuesday. According to various reports the company is preparing to finally reveal what it calls, Project Libra, with partners including companies like Visa and Mastercard.

Facebook is the best performing of the so called “FAANG” stocks this year and is up over 40% year to date. “FAANG” refers to a group of tech and internet stocks which includes Facebook, Amazon, Apple, Netflix, and Google.

The social media giant has also been under tremendous pressure from government regulators due to various privacy issues and most analysts think the crypto project may gave the company a big lift in more ways than one.

“We believe this may prove to be one of the most important initiatives in the history of the company to unlock new engagement and revenue streams, ” RBC analyst Mark Mahaney said.

Other analysts agreed.

“We believe this is a major initiative for Facebook, and one that has the potential of putting the company front and center in areas beyond advertising, including commerce and financial services, materially expanding its total addressable market and growth prospects,” analysts at SunTrust said. “It reduces the potential for regulatory scrutiny and opposition on anti-trust grounds (especially in the current environment), given Facebook’s consortium approach and the varied nature of the partners.”

Facebook is not just looking to be a player in the social media space either, according to analysts at MoffettNathanson.

“Facebook has its eyes set on becoming the world’s leading ecommerce platform as well,” they said.

Here’s what else the analysts are saying about Facebook’s crypto launch:

SunTrust- Buy rating

“We believe this is a major initiative for Facebook, and one that has the potential of putting the company front and center in areas beyond advertising, including commerce and financial services, materially expanding its TAM and growth prospects…It positions the company as one of the key actors at the center of the crypto currency development, and a main architect of the future of this emerging and important trend. While crypto currencies have existed for several years now, no other company could bring the combination of user scale, brand support and balance sheet, which Facebook can in our opinion…It reduces the potential for regulatory scrutiny and opposition on anti-trust grounds (especially in the current environment), given Facebook’s consortium approach and the varied nature of the partners.”

MoffettNathanson- Buy rating

“We believe a Facebook cryptocurrency-based payments system could be especially useful in countries with high inflation/unstable banking systems and for cross-country remittances. So, Facebook’s commerce ambitions do not appear to be limited to developed markets. Rather, Facebook has its eyes set on becoming the world’s leading ecommerce platform as well.”

RBC- Outperform rating

“We believe this may prove to be one of the most important initiatives in the history of the company to unlock new engagement and revenue streams, and we plan to provide an analysis of the White Paper to help investors analyze the underlying cryptoeconomics of the token. We believe Facebook will use crypto to facilitate a platform for: 1) Payments; 2) Commerce; and 3) Applications & Gaming. And we believe this strategy is a multi-step process, starting with a focus on user engagement through messaging and leading to further monetization with each subsequent, deeper step – a similar strategy that has worked well for Facebook’s Core Advertising business.”

Bank of America- Buy rating

“With more than 2.5 billion users, Facebook and its partners could be a significant endorsement of cryptocurrency and a notable addition to the Facebook app ecosystem. Although many questions remain on ease of use and potential adoption as there are very viable online payment alternatives in place, the consortium will likely get significant press/visibility and could be a medium-term catalyst for eCommerce activity on Facebook. We see the launch as an important initiative for the company as it builds out a more private messaging ecosystem with eCommerce capabilities.”

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Facebook to ‘take out’ stock high after crypto launch

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CNBC’s Jim Cramer on Monday said that Facebook‘s reported plans for a cryptocurrency is a reason for investors to get behind the social media giant’s stock.

The coin launch, if it were to happen as expected in the near future, would lead Facebook’s stock to “take out its high,” Cramer said on “Squawk on the Street. “

Shares of Facebook were about 3% higher on Monday, trading around $187 each. The stock would have to jump more than 16% to eclipse its all-time high of more than $218 in late-July 2018.

“This is going to be the biggest thing that’s happened to Facebook in years,” Cramer said. “It will be vital.”

It all started about a year ago when Facebook appointed former PayPal executive David Marcus to begin exploring options with blockchain.

Last week, the Wall Street Journal reported that Uber, PayPal, Visa, and Mastercard have signed up to support Facebook’s crypto effort known internally as Project Libra.

Cramer, host of “Mad Money, ” is in good company thinking a Facebook digital coin will be huge.

In a recent note, RBC Capital Markets analysts Mark Mahaney and  Zachary Schwartzman wrote that they believe  “this may prove to be one of the most important initiatives in the history of the company to unlock new engagement and revenue streams.”

Recent reports that Facebook will unveil its cryptocurrency as early as this month have also boosted the price of bitcoin. The world’s biggest digital coin jumped across the $9,000 level on Sunday, on the thought that Facebook getting into crypto would add legitimacy to the industry.

However, bitcoin is still worth less than half of its all-time highs near $20,000 in December 2017.

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The red-hot IPO market could mean bad news for future market returns

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Beyond Meat CEO Ethan Brown (C) celebrates with guests after ringing the opening bell at Nasdaq MarketSite, May 2, 2019 in New York City.

Drew Angerer | Getty Images

The red-hot market for new public companies in 2019 like Beyond Meat and Chewy could spell bad news for the broader stock market in the year ahead.

An uptick in IPO activity is correlated with a downturn in S&P 500 returns over the following 12 months, Bernstein equity strategist Noah Weisberger warned clients in a note on Monday. That’s because companies looking to go public tend to wait to take advantage of what they perceive to be the market’s richest valuations, at or near levels many investors feel the market many be overpriced, the equity strategist told clients.

It’s also because of “the notion that incremental IPO supply is difficult for the market to digest, suppressing forward returns,” Weisberger wrote. “IPO activity is (mildly) cyclical, as management teams take the opportunity to go public while being buoyed by favorable economic conditions.”

“Interestingly, the economic expansion which began in late 2016 was not matched by a pickup in IPO activity until early 2019, suggesting that this current wave of IPOs may simply be catching up to growth,” he added.

As the Bernstein chart below illustrates, more IPO activity is negative related to future S&P 500 returns. More IPO activity in the prior 12 months tends to be an indicator of market losses to come.

“Said differently,” Weisberger said. “IPO activity leads and is negatively correlated to market returns” with a value of -0.3.

A recent wave of IPOs has taken Wall Street by storm, with names like meat-alternative company Beyond Meat, online pet retailer Chewy and cybersecurity firm Crowdstrike up 163%, 78% and 70%, respectively, during their first day of trading.

The Renaissance Capital IPO ETF, a basket of the 60 or so most recent large IPOs, is up 35% this year, more than twice the performance of the S&P 500.

“Looking back to the mid-1980s, IPO activity has had a clear ebb and flow. While the late 1990s occupy a special place in market history, IPO activity was outsized all decade long, peaking in early 2000,” Weisberger wrote.

But while the meteoric rise of stocks representing beefless burgers and Fido’s squeaker toys has made a number of insiders and shrewd investors rich, some are a bit more concerned. Many of the so-called IPO unicorns rely on expectations for their rapid growth for their lofty valuations, a bet that could backfire if the market sours as some worry.

Today’s IPOs are essentially, a “very bright private equity crowd desperately hitting a fleeting late cycle bid after missing that bid in Q4 and looking down the barrel of a 20 percent U.S. equity market drawdown,” Larry McDonald of the Bear Traps Report told CNBC in March.

“They should have done these deals all last year, and they put it off,” he added at the time, noting that the Federal Reserve later swooped in to save the day by signaling a pause in its cycle of rate hikes. But that insurance may not always be there.

Economists and investors are preparing for Fed’s next policy move announcement later this week, eager to see if the central bank telegraphs a rate cut amid weakening economic data worldwide. Some recession indicators, like the partial inversion of the yield curve, have also spurred market angst and prompted some to put more money in safer assets like bonds and gold.

“The relationship between IPO activity and forward returns was especially pronounced in the dot-com bubble and again in mid-2014,” Weisberger added. “Interestingly, there was not as dramatic an uptick in IPO activity during the lead-up to the Global Financial Crisis, although some notable transactions such as Blackstone’s IPO did occur at that time.”

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