Crazy Hazy Days of Summer

Crazy hazy days of summer.  Stocks swung wildly yesterday opening in the red and clawing their way into the black.  Fears of global economic slowdown brought on by central bank easing gave way to dip buying.

 

MY TWO CENTS

 

1.  Make up your mind!  Yesterday’s bipolar market underscores the confusion on the part of traders in the current economic climate.  Time and again I wonder in my market note how markets will respond to economic data.  But shouldn’t it be plain and simple?  Bad economic data is bad for companies and stocks, so stocks should sell off and vice versa, right?  Not exactly.  It used to be that way when I started on Wall Street three decades and several recessions ago, but things have changed since then, namely the rise of the central bankers.  The Federal Reserve was always a factor in the market.  During expansions, they largely worked in the background injecting and removing liquidity to keep markets running efficiently.  It was only during extreme times of either overheating inflation or recessions did the Fed rush in to make bold policy adjustments.  In fact, Fed watching was something attributed only to stodgy, pragmatic bond traders who eyed the tape for daily economic releases while overanalyzing FOMC meeting transcripts.  Enter Alan Greenspan who chaired the Fed from 1987 to 2006.  On December 5, 1995 at the height of the Dot Com bubble, Greenspan gave a speech in which he referred to irrational exuberance being the cause of inflated stock values.  His comments caused a global market selloff and marked the beginning of the end of the Dot Com Bubble .  Since that moment, savvy stock traders began to take more notice of the Fed.  Turning the clock forward the financial crisis and great recession in which the Fed had to jump in with aggressive operations to shore up the crumbling economy, first with aggressive rate cutting and eventually with quantitative easing.  The Fed adapted a ZIRP (Zero Interest Rate Policy) strategy and bought bonds from the public to shore up markets.  The strategy became known as the Fed Put, meaning that the Fed was always there to protect stocks from going down.  This spurred the beginning of the longest bull market in history.  It was also during this period that traders and investors alike began to pay very close attention to every move of the Fed, always in fear that the Fed would change policy and take away the punch bowl (as it was referred to at the time).  It was during that time period that “bad is good” became a thing.  Bad economic data meant that the Fed would not reverse course, which meant it was safe to continue buying stocks.  It was also during that period that the Fed recognized that it was able to keep markets happy by simply managing expectations through carefully constructed statements and speeches.  Turn the clock forward once again to Dec. 2018 in which the stock markets crashed in response to the Fed raising interest rates.  Chairman Powell was able to turn markets around by simply hinting that the Fed might stop raising rates.  The hints gave way to gestures and more speeches which kept markets moving up and ultimately resulted in the Fed’s first rate cut in over a decade.  Markets reacted by selling off because the rate cut was not as dovish as many were hoping for.  The markets are now fully addicted to the Fed, who is completely in control of expectations.  Yesterday morning, I reported that three central banks cut interest rates which resulted in a selloff of stocks on the realization that the global economy might be in bad shape.  What turned things around?  Expectations that the Fed will have to follow suit and lower rates further in their next meeting in September, now a 78.8% chance of a -25 basis point cut and a 21.2% chance of a -50 basis point cut.  Whether it happens or not is immaterial, but the expectations of Fed exuberance was all that was necessary.

 

2.  The slippery slope gets more slippery.  As the fate of global economies get murkier and murkier with a raging trade war between the world’s two largest economies, increasing geopolitical tensions, record low unemployment, and stalled inflation, markets have been gyrating.  Stocks make new all time highs one day only to selloff to important support levels the next.  For bonds it has been a relatively steady growth path as traders are predicting economic slowdown resulting in a  flattening of the yield curve.  A flat yield curve results in term premiums getting smaller, meaning that investors are compensated very little for buying longer maturity bonds. As an example, 2-year treasury bonds have a yield to maturity of 1.6% compared to the 1.73% yield of a 10-year treasury.  Investors who commit capital for an additional 8 more years are rewarded with only 13 basis points more in yield … that is 0.13% in more stark terms.  Even more extreme is 3-month treasury bills which yield 2.02% which is 29 basis points more than the 10-year!!  The inverted curve is at its lowest since 2007, looked at by some as a predictor of the next recession.  For average investors the record low yields, a flat yield curve, and a rate-cutting Fed mean more confusion and lower return on their investments.

 

THE MARKETS

 

Stocks mounted a comeback yesterday after opening sharply lower as fear gave way to greed with investors taking advantage of lower prices.  The S&P500 climbed by +0.08%, the Dow Jones Industrial Average slipped by -0.09%, the Russell 2000 fell by -0.09%, and the NASDAQ 100 advanced by +0.41%.  Bonds jumped on global economic fears and 10-year yields rose by +3 basis points to 1.73%.  Oil slipped by -4.74% holding back the energy sector and the Financial Sector fell by -1.21% in response to lower global yields and the flattening yield curve.

 

WHAT’S NXT

 

– This morning we will get weekly Initial Jobless Claims which is expected to be 215k, same as last week.

– Wholesale Inventories are expected to have increased by +0.2% for June, for a second straight month.

– The Treasury will auction $29 billion 30-year bonds.  Watch this closely as yesterday’s 10-year auction was not well received.  The reason?  See my second point above.

– Before the bell we will hear from Kraft-Heinz and Viacom, amongst others.  After the bell earnings include CBS, Activision Blizzard, Uber Technologies, and Revolve Group.

daily chartbook 2019-08-08