Gravity

Gravity.  Stocks were hit for a second session yesterday as the CDC warned about the virus’ “inevitable” spread. Investors piled into safe asset bonds pushing yields to record lows.

N O T E W O R T H Y

That’s it?  Yep, that’s it, just 1.35% to loan your money to the US Government for 10 years!  You could always get more by lending your hard-earned money for a longer period, say 30 years.  Not really, you only get another half a percent or so for the additional 20 years of commitment.  If you think that is low, you are right.  Yields on both 10-year and 30-year treasury notes and bonds hit all-time lows yesterday.  What happened?  First let’s talk about the obvious.  The past two days have seen an adjustment in risk asset exposure.  That is a watered-down technical term for: stocks got slammed.  With all of the panic selling that occurred, there was a rush into safe-haven assets and at the top of that list was the US Treasury note. Remember that when prices on bonds go up as demand increases, yields to maturity go down.  Now with the obvious out of the way, let’s cover a few more points.  Who is actually rushing back and forth between stocks and bonds so aggressively?  The likely suspects include speculative traders and hedge funds.  Starting with hedge funds, supposedly on the forefront of the markets, they take highly speculative bets hoping to exceed market returns attributed to volatility (also referred to as Alpha by insiders).  Many fund managers have been amassing large positions in equities as the new year turned over a fresh page and stocks looked unstoppable, despite the mounting crisis in China.  The markets’ unflappable behavior gave many managers the signal they needed to pile on their stock investments.  Hedge funds also typically utilize margin to enhance their potential gains. Goldman Sachs noted that margin amongst its hedge fund clients had risen to record levels just prior to the markets down-swing.  This means that they were very bullish just before things got rough. Another thing about margin is that when things go against you, it enhances your losses… that is to say you lose big time.  Those big time hits usually cause rapid selling to cut losses which ultimately results in even more volatility in equities.  The knee-jerk selling moves in equities are typically followed by knee-jerk buying of treasuries.  In that world all moves are accentuated… we get lots of volatility.  Add speculative traders to the mix and things appear even more wild. They try to take advantage of the rapid exodus by selling equities (either by shorting or with options) and buying treasuries hoping to capitalize on the short-term momentum.  Finally, we have bond traders who are speculating that things are going to get rough for the US economy and that the Fed will lower interest rates.  They speculate by buying longer maturity treasuries… causing yields to go down further.  The net result is that yields find themselves at all-time lows.  The speculative pressure put on the back end of the yield curve causes it to flatten and invert.  The 3 month – 10 year yield spread first dipped into negative (or inverted) territory in late January as news of the Coronavirus just hit.  After briefly bouncing back into the positive, the curve went negative again and has remained so for the past 10 days or so.  You may remember that this same part of the yield curve was inverted for a good part of 2019 until the Fed lowered interest rates.  Though they have been tight-lipped about it, there is plenty speculation that they will indeed have to cut rates to calm the financial markets.  According to Fed Funds futures, there is a 64.1% chance of a rate cut by April.  Just one week ago, those odds were just 24.6%.  A cut may not be out of the question.  The Fed’s self-appointed side job is to keep financial markets (really stocks) from getting spooked. Consumers are more confident when the stock market is healthy. Happy consumers keep the economy growing, which is really the Fed’s main job.

THE MARKETS

Stocks slid further yesterday after the CDC unnerved the markets warning that the spread of the Coronavirus to the US was inevitable.  Early gains were quickly eclipsed by selling causing markets to close near session lows.  The S&P500 dropped by -3.03%, the Dow Jones Industrial Average slid by -3.15%, the Russell 2000 traded off by -3.45%, and the NASDAQ Composite Index sold off by -2.77%.  Bonds climbed and 10-year treasury yields fell by -2 basis points to 1.35%.  Crude oil had another tough day, falling by -2.97% and putting further pressure on an already tumbling energy sector.

NXT UP

– New Home Sales are expected to have grown by +3.5% month over month compared to a -0.4% drop in the prior month.

– The Treasury will auction $41 billion 5-year notes.

– This morning Lowe’s beat expectations.  We will hear from Papa Johns, TJX, JM Smucker, and Wendy’s before the bell while L Brands, Square, Etsy, Marriott International, Teladoc, and Carvana will announce after the close.

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