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Today’s Points:

• Apple’s results didn’t reassure investors on tariffs; neither did Amazon’s.
• Price competition has come to weight-loss drugs — and Lilly’s shares sold off.
• Markets still seem to be understating the economic impact of tariffs.
• For one thing, they’ll likely delay the Bank of Japan’s next hike (meaning more cheap money). 
• AND: Beckham bends it to 50.

When is an unambiguous recession indicator something investors can completely ignore? Answer: When tariffs are clouding perception so badly that nobody is quite sure of anything. That at any rate seems the conclusion as we approach the end of the first-quarter earnings season, while the hard economic data for April begin to roll in. 

The Institute of Supply Managers’ manufacturing index, long regarded as one of the best leading indicators of economic growth, was on the face of it alarming. The overall headline number is below the 50 that separates expansion from recession. Within it, the report on how much manufacturers were producing was downright alarming:

These numbers don’t prove a recession is imminent, but they should certainly prompt risk managers and allocators to shift toward assets that do best in a downturn. That should mean bond yields go down. This is what happened to the two-year Treasury yield on Thursday:

So, unmistakably negative manufacturing numbers caused a sharp rise in bond yields. Why? Mainly because of some bizarre inconsistencies in the report. The overall number wasn’t as bad as the consensus had predicted, largely because new orders were way ahead of estimates. What’s strange is that those estimates had been compiled by comparing with data from new orders coming out of the industrial surveys run by different branches of the Federal Reserve. 

In the following chart, from Omair Sharif of Inflation Insights LLC, the red line is the official ISM new orders number, while the dark blue shows the implied figure generated by the regional Fed surveys

Sharif suggests the discrepancy may come from the survey’s different weightings, as the overall ISM is driven by sectors’ overall contribution to gross domestic product — so sectors such as chemicals or computers will take a greater weight.

Another problem interpreting the data comes, inevitably, from tariffs. The overall new orders index improved slightly, but dropped for exports to a low previously seen only in recessions. Tariffs are meant to stimulate a shift of demand from exporters to domestic manufacturers, and they are perhaps already having that effect. It does make it harder to gauge the overall direction of the economy:

Similar strictures apply to the earnings season. The first quarter’s results have generally been better than expected, by a greater margin than usual. But the direction of analysts’ estimates for the full year is unusually negative, as illustrated by Andrew Lapthorne, chief quantitative strategist at Societe Generale SA. The downgrade for the US is worse than for most, and Japan is the only spot of relative optimism:

Downgrades like this are unusual. As Lapthorne summarized:

Earnings are being downgraded, margins are under pressure and analysts are posting 2.5x more downgrades than upgrades in the S&P 500, a rarity during a reporting season. And this is all before we start incorporating tariffs impact.

Thursday’s biggest corporate news came after the close as Amazon.com Inc. and Apple Inc. reported. Compared to the two Magnificent Seven companies that reported Wednesday, Meta Platforms Inc. and Microsoft Corp., their business models are far more directly exposed to international trade. Apple’s manufacturing is centered outside the US, and Amazon is a major importer. Wednesday’s M&M combination received a rapturous reception after hours. This is what happened to A&A:

The problem for Apple was that it admitted that costs were rising — it estimates an extra $900 million thanks to tariffs in the next quarter — and that sales in China had disappointed. Amazon projected profits for the current quarter that were below prior expectations, thanks to the problems caused by tariffs. The stock recovered somewhat during the earnings call as executives emphasized that they were continuing to invest heavily in artificial intelligence, and had not yet noted any drop in demand due to tariffs. 

None of this suggests that this is a time to be too confident about anything — even though the market has now completed its recovery from the April 2 Liberation Day selloff. And it’s hard to say that the valuations reflect this. Compared to forward earnings, the S&P doesn’t seem particularly expensive, although it’s not cheap, either. Compared to sales, it looks massively overpriced:

The two indicators have diverged because companies have managed to make steadily bigger profit margins. The market by implication is confident that those margins can continue. That suggests great confidence either that tariffs won’t happen, or that companies can cheerfully pass them on to their customers. Neither is a safe bet.

Tariffs are creating confusion, as they had to. It’s probably best to treat the market recovery as a handy opportunity to make further transfers out of US stocks and into geographies that should be less affected.

Weighing Up Weight-Loss Drugs

There was another shock to the system from Eli Lilly & Co., now the biggest US drugmaker by market cap thanks to the success of its weight-loss drugs Mounjaro and Zepbound. Its earnings were ahead of consensus, thanks in large part to a 45% year-on-year increase in weight-loss drug sales. But that didn’t help the shares. They dropped 11%, for their worst single day since the crisis of 2008: 

Why? The company brought down its guidance for the full year a little, and didn’t use tariffs as an excuse. Then, news broke that CVS, one of the largest pharma retailers in the US, had decided to replace Lilly’s weight-loss drugs on its recommended list with rivals from the Danish group Novo Nordisk A/S. They did this by discounting. The advent of price competition in this market was inevitable as the products matured. It’s welcome for patients, but not for shareholders. Shares in Novo’s American Depositary Receipts also fell slightly after the news, despite its success in dislodging Lilly. 

The broader issue is that markets will always have a problem valuing innovative products when they’re going through explosive growth. Lilly’s success in bringing weight-loss drugs to market naturally pushed up the multiple on earnings that investors were prepared to pay. It will inevitably fall as the new drugs come online and competition eats into profits. Where should the price/earnings ratio come to rest?

For several years before the drugs came on stream, the company traded near 20 times earnings. That ballooned to 80. Even after Thursday’s selloff, it remains above 40:

Weight-loss drugs have the potential to revolutionize health care and improve standards of living. But amid the excitement, it looks as though the market overvalued a new technology. It’s not the first time this has happened, and it won’t be the last. 

Look East

Japan continues to be the exception, whether it likes it or not. The Bank of Japan is enthusiastic to get on with returning monetary policy to something like normal, after decades of artificially low rates and bond market interventions. But events keep getting in the way. 

The BOJ monetary policy meeting Thursday produced a dovish surprise. Rates were unchanged as expected, but the bank also cut forecasts for both growth and inflation, predicting that it would take longer to reach its target for price rises on a sustainable basis — which in the case of Japan means raising, not lowering it.

As a result, the yen weakened. Several times now, the currency has strengthened toward the landmark level of 140 per dollar, and that continues to act as a ceiling. Yet again, traders weren’t prepared to go through that level, and now it’s weakening again:

For many outside the country, this is good news. Japan and its low rates have been the world’s most reliable supply of cheap money for years. Since the end of the pandemic year of 2020, a carry trade of borrowing in yen and parking in the Mexican peso, or even the dollar, and pocketing the difference has — remarkably — beaten the total return of the S&P 500. 

Any doubts about the importance and pervasiveness of the carry trade were removed last August when a sudden appreciation of the yen — and very sharp loss for carry trades — briefly drove a global selloff for risk assets. That unwind is over, and the trade has again made money since last summer’s lows. And both the dollar and the peso carry trade are still somehow beating the S&P:

It’s possible to overstate what the BOJ has just announced. Overnight index swaps’ estimate of where its target rate will be at the end of this year barely moved. It remains the case that intensifying concerns over trade policy are perceived to have cut about 25 basis points from where the BOJ can reach this year:

Tariffs are of course the essential unknown. Chairman Kazuo Ueda said that he and his colleagues were working on the assumption that US tariffs will end up lower than announced on Liberation Day, but above 10%. Other outcomes are possible. That undermines what would otherwise be a strong Japanese growth outlook, thanks to labor shortages that have spurred consumption by driving up wages. Shigeto Nagai of Oxford Economics argued: “Consumption will not be strong enough to offset weak exports and investment, because the damage from tariffs could make it more difficult for small firms to keep raising wages.”

It’s probably best to work on the assumption that the BOJ is bending to the forces that are trying to accommodate the global shock from US tariffs. Just as many countries are boosting their fiscal spending to deal with the problem, so Japan is keeping the cheap money flowing. This isn’t healthy for the longer term, but it does reduce the risk of major problems in the year ahead. 

Survival Tips

Who would’ve thought? Photographer: Markus Schreiber/AP Photo

Happy 50th birthday David Beckham! Somehow, soccer’s golden boy is growing old. Like many, I have mixed feelings about Becks; he played for clubs (Manchester Utd and Real Madrid) that I don't much like, he became a fashion clothes horse, he’s overdone the tattoos, and his fame owes much to his looks and popstar wife — just compare Google images searches for Beckham with Lionel Messi and Cristiano Ronaldo. All the photos of the latter two show them wearing soccer kit; Beckham's looks like a catalogue from a modeling agency. All that said, he’s still married to Victoria after more than 25 years, he’s building something great at Inter Miami, he tirelessly puts his fame to work for charities, and even though he wasn’t in the same rarified class as Messi and Ronaldo, he was a fantastic footballer. Just see this and this and this and maybe forgive him for this. Congratulations on 50 years very well lived, David.

Points of Return is going to take a brief hiatus while I go to a high school reunion. (My 40th, so help me.) We’ll be back for the Fed meeting on Wednesday. Enjoy the weekend everyone. 

More Charts on the Terminal from Points of Return: CHRT AUTHERS

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