The Sound of Silence

The sound of silence.  Stocks had a mixed close yesterday with no news on the trade front and silence from the Fed ahead of its policy meeting.  Capital moved out of bonds and into value stocks yesterday pushing treasury yields higher – good news for some and bad news for others.

 

MY TWO CENTS

 

1. “Ain’t no laws when you’re drink’n Claws”.  A popular Internet meme amongst the 20 to 30-something set, it refers to the recently popularized alcoholic seltzer White Claw.  As you might expect the meme has drawn a bit of controversy from… the law.  But I am here to refute the meme from a different perspective: economic law.  A few days ago, news outlets began to report a shortage of the drink, which comes in small white cans.  Its popularity is growing so quickly that stores can’t keep shelves stocked and the company is having problems keeping up supply.  Increased demand, supply shortages?  That equals, of course, price increases.  Entrepreneurs have been cashing in with their private stocks as folks clamor to enjoy the last few warm days before Autumn sets in… that’s right Autumnal Equinox is just 13 days away.  So even pop culture is subject to the laws of supply and demand.  These same laws have been causing some upset in the energy markets with crude rallying earlier in the year in response to planned supply cuts by OPEC+, only to falter and stagnate through most of the summer.  OPEC (Organization of Petroleum Producing Countries), which is a cartel, has aimed to carefully control the supply of crude oil.  Why?  To control prices in order to assure the producing nations ongoing profitability.  In past years, OPEC was a powerful body as there was steady demand for the commodity.  As more economies became industrialized, demand increased.  Think of China’s industrial growth – they are the second largest consumer of crude oil behind the US, consuming 10.48 million barrels per day (according to US EIA).  OPEC, which was originally composed of 4 Middle Eastern countries and Venezuela had a very powerful influence on price as most of the world’s supply came from those regions.  In the years since its founding, many factors have changed the dynamics of crude supply.  Namely: hydraulic fracturing in the US.  Known commonly as fracking, the process enables lower cost removal of crude oil from US shale deposits.  The rise of the technology has enabled the US to become the largest producer of crude oil in the world, ahead of Saudi Arabia.  Increase in supply of a once artificially scarce resource means… decreased prices.  OK, so we know about fracking, what makes things different now?  The other side of the equation: demand.  Yes, more and more folks are becoming less fossil fuel independent, but not nearly enough to impact the market just yet.  As mentioned above, China is the second largest consumer of crude in the world and with the Chinese economy slowing down, so does demand for crude oil.  Increased supply and decreased demand equals lower prices.

 

2.  These yields actually mean something.  With bond yields moving around so much lately, the media has largely been focused on traders who purchase bonds hoping to make money as they increase in price.  The real story though should be yield impact on all markets.  2019 has seen 30-year treasury bond yields go below 2% for the first time in history.  10-year treasuries started the year yielding around 2.7% and have since dropped as low as 1.45%.  I have reported on the growing amount of negatively yielding debt amongst developed countries.  So yields are low, really low.  If you factor in inflation, real yields are even lower, though inflation does not seem to be a problem in most places.  When yields decline so quickly there is a point where investors begin to shun bonds for higher yielding asset classes.  The S&P500 has a dividend yield of 1.91% making large cap stocks an attractive alternative to investors who are seeking yield (if you don’t factor in the risk associated with equities relative to bonds).  As the Fed is expected to continue lowering rates and a potential for advances in trade talks between the US and China have been increasing, investors have been rotating out of low yielding bonds and into higher yielding equities.  The result?  Yields on 10-year treasuries have risen back to levels of early August.  The higher yields are good news for financial stocks and fixed income investors who are thirsty for yield.  Higher yields are bad news for growth stocks, whose valuations depend on low costs of capital.  Did I mention that costs of borrowing for companies also goes up? Not to worry, as yields start to get higher, investors will start to sell stocks and buy bonds, starting the cycle once again.

 

 

THE MARKETS

 

Stocks were unable to gain ground yesterday as investors had very little news to trade on.  The S&P500 fell by -0.01%, the Dow Jones Industrial Average climbed by +0.14%, the Russell 2000 jumped by +1.27% as investors sought out bargains, and the NASDAQ Composite Index pulled back by -0.19%.  Bonds dropped yesterday with the aggregate bond index sliding by -0.33% and the 10-year treasury yield climbed by +8 basis points to 1.64%.  Crude oil got a boost from Saudi Arabia naming a new oil minister committed to reform.  WTI crude jumped by +2.35% helping the energy sector outperform all others yesterday.

 

WHAT’S NXT

 

– The Bureau of Labor Statistics will release its JOLTS Job Openings which is expected to show a decrease in openings from 7.348 million to 7.331 million.

– The Treasury will sell $28 billion year-bills and $38 billion 3-year notes.

– Apple will hold a product event in which they are expected to announce new products.

– GameStop, Dave & Busters, and Restoration Hardware will announce earnings after the bell.

daily chartbook 2019-09-10