Should We Be Concerned About the Yield Curve Inversion?

March 25, 5:00 pm EST

There was a big technical break in the interest rate market on Friday.   And the yield curve inverted.

What does it mean, and should we be concerned?

First, when people talk about the yield curve, they are typically talking about the yield on the 3-month Treasury bill versus the yield on the 10-year government bond.  The latter should pay more, with the idea that money will cost more in the future (compensating for inflation and an “uncertainty about the future” premium).

When the 10-year is paying you less than you could earn holding a short term T-bill, the yield curve is said to be inverted.  And this dynamic has predicted the past seven recessions.  Why?  Because it typically will be driven by a tighter credit environment, namely banks become less enthused about borrowing in the form of short term loans, to lend that money out in longer term loans.  Money dries up. Unemployment goes up. Demand dries up. Economy dips.

With this in mind, today the 3-month treasury bill pays 2.44%. And the 10-year government bond pays 2.41%.  The spread is negative which makes for an inverted yield curve.

Now, while an inverted yield curve has preceded recessions with a good record, we’ve also had inverted yield curves and no recession has followed.

What isn’t talked about much, is why the yield curve is inverting this time.  It sort of spoils the drama to talk about the “why”.  Unlike any other time in history, we have an interest market that has been explicitly manipulated by global central banks for the past decade (via global QE).  And we have one major central bank (the Bank of Japan) remaining as a buyer of unlimited global assets (that includes U.S. 10 years, which pushes the 10-year yield lower).

Remember, the Bank of Japan’s policy of targeting their 10-year government bond yield at zero, means they will be a buyer of unlimited bonds to push JGB yields back toward zero (price goes up, yields go down).  And when the tide of global rates is rising, pulling UP their yields, they will be a buyer of whatever they need to, to push things back down (and they’ve done just that).

What does that mean?  It means, as the Fed has been walking its short-term benchmark rate higher, the “long-end” of the interest rate market (the 10-year yield) has been anchored by central bank buying – buying by all major central banks for the better part of a decade, and now led by the BOJ.  That has kept a lid on the U.S. 10-year government bond yield, and global government bond yields in general.

With this at work, there have been few things better telegraphed than a U.S. yield curve inversion, as the Fed has told us for years that they will march their short-term rate beyond the anchored 10-year yield.
It’s often dangerous to say “this time is different”, but I think it’s fair to say that the past yield curve inversion/recession analyses don’t compare, when you have both components (the front-end and the long-end) completely controlled by global central banks for more than a decade.  Join me here to get my curated portfolio of 20 stocks that I think can do multiples of what broader stocks do, through the end of the year.
Fed Reset Is A Pre-Emptive Strike Against The Worst Case Scenario

March 20, 5:00 pm EST

The Fed met today and confirmed the signaling we’ve seen since early January.

With the luxury of solid growth, low unemployment and subdued inflation, they have been signaling to markets, since January, that they will do nothing to rock the boat.  That move has restored confidence and stock prices (a reinforcing loop).

So, the Fed has gone from mechanically raising rates (as recently as December) to sitting on their hands.  And today they are forecasting no further rate hikes this year, and they are ending the unwind of their balance sheet in September (ending quantitative tightening).

This all looks like a move to neutral, but given the rate path they had been telegraphing up until the end of last year, this pivot is effectively easing — especially since these moves look like pre-emptive strikes against the potential of Brexit and U.S./China trade negotiations going bad.

With that, we have a big technical break in the bond market today.  The U.S. 10-year government bond yield (chart below) broke this important trendline today.

 

This trendline represents the “normalization” of market rates following the Trump election.  Following the election, with the optimism surrounding Trumponomics, the market started pricing OUT the slow post-recession economic growth rut, and pricing IN the chance that we could see a return to sustained trend growth.

So, what is it pricing in now?  I would say its pricing in the worst-case scenario – a no deal with China.

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For Tech Giants, Compliance Costs Will Change The Business Model

March 19, 5:00 pm EST

We’ve seen the verbal and Twitter shots taken by Trump at the tech giants since he’s been in office.  And the threats have slowly been materializing as policy.

We get this today …

 

With this in mind, we’ve talked quite a bit about the domestic leveling of the playing field. The tech giants (Facebook, Amazon, Netflix, Google, Twitter …) are on the regulatory path to being held to a similar standard that their “old economy” competitors are held to.  They may have to pay for real estate (i.e. bandwidth). They may be scrutinized more heavily for anti-competitive practices.  And they may be liable for content on their site, regardless of who created it.

The latter was the subject of the Trump tweet today.  And he was asked about it in a press conference.  He said we “have to do something about it.”  He called the discrimination and bias “collusion” from the tech giants.

The regulation is coming. And depending on the degree, at best, it changes the business models of these “disrupters.” At worse, it could destroy them.  Imagine, Facebook and Twitter being held liable for things their customers are saying on their platforms.  That’s endless compliance to ward of business killing liabilities.

As compliance costs go UP for these companies.  The cost goes UP for consumers. The model is changed.

On a related note, remember, last September the S&P 500 reshuffled the big tech giants.  Among the changes, they moved Facebook, Google and Twitter out of the tech sector and in to the telecom sector (re-named the “Communications” sector”).

Here’s what that sector ETF looks like since …
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Fed Meeting This Week, But They Have Already Told Us Where They Stand

March 18, 5:00 pm EST

Stocks open the week in breakout mode.

We’ve now taken out the December highs, the levels that preceded the sharp 20% plunge.

So, now we have this chart as we enter a week with a Fed meeting on the agenda.

 

This leaves us up 13% on the year, and with another 4% climb to regain the October all-time highs.

The Fed meets this week.  With a relatively light data and news week, the Fed will get plenty of attention.  But remember, we know exactly where they stand.  They want to maintain confidence in the economy.  And they know the stock market is an important contributor (and can be a dangerous detractor) to confidence.  They need stocks higher.

That’s why on January 4th, the Fed responded to the plunging stock market by marching out the current and past two leaders of the Fed to tell us the “normalization phase” on interest rates was over (i.e. no more rate hikes).

And that’s why on March 10th (just a week ago), in response to a 4% one-day plunge in Chinese stocks and some loss of momentum in the U.S. stock market rebound, Powell followed the script of his predecessor Ben Bernanke, and spoke directly to the public through an exclusive 60 Minutes interview, to reassure the public that the economy was in good shape, and that the Fed was there to ensure stability.  If you bought stocks after both interviews, you felt no pain and have been rewarded handsomely.

With the above chart in mind, below is the chart we looked at to start the year, as we discussed the potential for a V-shaped recovery following the Fed’s January 4th strategic pivot.
From my January 4th Pro Perspectives note:
“We entered the year with the idea that the Fed would need to walk back on its rate hiking path this year (possibly even cutting, if the stock market environment persisted).  And today, just days into the new year, we get the Fed Chair Powell, former Fed Chairs Yellen and Bernanke telling us that the Fed is essentially done of the year, unless things improve … [as for stocks] We broke a big level today on the way up in the S&P 500 (2520) and it looks like a V-shaped recovery is underway, to take us back to where stocks broke down on December 3rd.  That would be 12% from current levels.” So, far so good. The Fed has stabilized confidence.  The question now is, do we get a deal with China soon?  If not, we may find a rate cut, in the near future for the Fed.  The former Minneapolis Fed president, and former voting FOMC member, is calling for a cut, as a pre-emptive strike to a slowdown.Remember, 2018 was the first since 1994 that cash was the best producing major asset class (among stocks, real estate, bonds, gold).  The culprit was an overly aggressive Fed tightening cycle in a low inflation recovering economy.  The Fed ended up cutting rates in 1995 and spurring a huge run up in stocks (up 36%).

Join me here to get my curated portfolio of 20 stocks that I think can do multiples of what broader stocks do, coming out of this market correction environment.
Bottom May Be In For China

March 15, 5:00 pm EST

As we end the week, let’s take a look at what China is doing to stimulate the economy.

If the world has been worried about global growth, because of the toll that trade reform is taking on China, then the actions China has been taking, and has discussed overnight, should be THE focus for markets — in addition to the status of a U.S./China trade deal.

Remember, by the end of last year, much of the economic data in China was running at or worse than 2009 levels (the depths of the global economic crisis).  It’s clear that the era of double-digit growth in China is over (at the expense of the rest of the world).  The question is, how low can it go, without threatening an uprising against the regime.  They seem to be willing to do ‘whatever it takes’ to defend the 6% growth number.

With that, as we’ve discussed, for a sustained recovery in global growth, expect others to follow the lead of the U.S. with big fiscal stimulus and structural reform (i.e. Europe, Japan …. and China).  With the news overnight from Chinese Premier Li (who has been the pointman for U.S./China trade negotiations), China is preparing an assault on the growth slowdown.  He’s promising an aggressive mix of monetary and fiscal stimulus.

They are looking to do large-scale tax cuts. They’ve promised billions of dollars infrastructure spending.  They’ve already cut the reserve requirement for banks five times in the past year – and they are looking to do more to motivate bank lending.  And they are targeting to create 13 million jobs this year in the manufacturing sector and in small business.

As we’ve discussed, Chinese stocks are reflecting optimism that a bottom is in for the trade war and for Chinese economic fragility.

 
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Why Global Markets Haven’t Been Troubled By Brexit

March 13, 5:00 pm EST

We haven’t talked much about the Brexit drama.

Why?  Because it has been noisy, yet unlikely to create any shock-waves through the global economy.

Even the knee-jerk reaction to the Brexit vote in 2016, didn’t have staying power.  The uncertainty that was quickly manifested in global stocks, was just as quickly reversed.  You can see it in the S&P chart below …

 

Why the sharp reversal?  And why isn’t Brexit a big shock risk?

We had seen a similar movie before: Grexit.  Greece’s EU and EMU partners talked tough about a “my way or the highway” bailout plan, which included harsh austerity. But when push came to shove, the Greek’s stood their ground, resisted the harsh austerity measures that came with the bailout, and it quickly became clear that Europe had more to lose, than did Greece, by the Greeks leaving the EU and (most importantly) leaving the euro. The Greek’s had negotiating leverage.  And they got concessions.
In the case of Brexit, the EU partners started with tough talk too, promising a dark and ugly future for the UK.  But the EU had/has plenty of risk (i.e. others following the lead of Britain … ex. Italy, Spain).  Clearly they both need each other to thrive.  The UK loses if the EU implodes.  The EU loses if the UK implodes.

The populist movement that gave us Grexit, gave us Brexit and then the Trump election, and recently a new government in Italy with an “Italy first” agenda.  It’s a movement of reform.  And reform is now becoming the norm, not the extreme. We’re hoping to see reform in China now too.

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Why The Fed Cares (A Lot) About Oil Prices

March 12, 5:00 pm EST

Remember, when oil prices began the fourth-quarter plunge from $76 down to as low as $42, we talked about the damage it would do to the inflation outlook, and how it may provoke a response from the Fed, which it has.

With today’s inflation data, you can see the impact of (yet another) oil price crash.  Headline inflation in the U.S. was running near 3% late last summer, the highest level since 2012. Now it’s 1.5%.

 

The Fed likes to talk about their assessment of inflation, excluding the effects of volatile oil prices. But they have a record of acting on monetary policy when oil is moving, especially in this post-crisis environment where deflation has been a persistent threat throughout.  They acted in 2016.  And they’ve acted in 2019.

Why?  They have the tools to deal with inflation.  They raise rates.  But the tools are limited to deal with deflation.  They cut rates.  But when rates hit zero, they have to get creative (like QE, negative rates, etc.).  And the consequences of losing the deflation battle are big.  When people hold onto their money thinking things will be cheaper tomorrow than they are today, that mindset can bring the economy to a dead halt. It’s a formula that can become irreversible.

So, we can see why the Fed has been pro-active in response to falling oil prices, falling stocks and falling inflation.  It can all lead to falling confidence.  And that can put them in the position of fighting the dangerous spiral of deflation.

That said, oil is on the rebound.  And as we discussed last month (here), with the quieting of controversy surrounding the Saudi government, it looks like a V-shaped recovery could be in store for oil prices (as we’ve seen with stocks).

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The Fed’s ’60 Minutes’ Strategy

March 11, 5:00 pm EST

We ended last week with a 4.4% plunge in Chinese stocks.  What followed, Friday morning (EST time), was an announcement that the Fed Chair (Jerome Powell) would be appearing on an exclusive 60 Minutes sit down interview Sunday night.

This is a rare occurrence, that the Fed Chair does a mainstream media interview/Q&A.  These Q&A’s are typically done in Congressional hearings, following Fed meetings or at select economic conferences.  The common theme:  He speaks economics and policy to economic and policy practitioners.

With that, this interview with 60 Minutes was clearly a desire to speak to the broader public.  In part, it was a response to the growing risks of a confidence shock (given the December stock market decline, Brexit drama and China/U.S. trade uncertainty).  It was an opportunity to tell the public that the economy is doing well, despite the media’s doom and gloom stories.

Also, in part, it was an opportunity to tell the public that the Fed is there to defend against shocks and panics, and that they won’t be swayed by politics.

Powell was also specifically asked about a few of the cherry picked data points the financial media has been parading around in recent days.  As we discussed Friday, without context, some of the data can sound ominous.  He added context, including for the  dip in retail sales from December.  Of course the retail sales hit was the result in the knee-jerk swing in confidence that comes with the December plunge in the stock market.  He said they would be watching the January number closely.  The January number today, indeed, was strong.

That (the interview and the confirmation of the retail sales data) was a catalyst for a big bounceback in stocks today.

Powell is following the script of the Ben Bernanke.  When Bernanke was directing the Fed through the storm of the financial crisis, he (and the Fed) were being killed in the media.  And the media set the tone for global leaders to take shots at the Fed too.  So, Bernanke took to 60 minutes to speak directly to the people – to set the record straight.  That interview set the bottom in the stock market — and it turned the tide in global sentiment.

Join me here to get my curated portfolio of 20 stocks that I think can do multiples of what broader stocks do, coming out of this market correction environment.
The Script For Stocks Continues To Look Like Another 2016

March 7, 5:00 pm EST

Stocks continue to back off after completing a full recovery of the December declines.

Here’s another look at the chart we observed on Monday, where you can see the big technical area of resistance (three prior highs) — and today we close back on the 200-day moving average (the purple line).

As we discussed on Monday, the failure of this level shouldn’t be too surprising, as a reasonable technical area to take some profits.

As stocks slide back, the media is quick to turn the attention back toward fears of global economic slowdown.  What’s the big difference between now and December?  The Fed has moved from telegraphing rate hikes to ‘neutral’ and sitting/watching.  The PBOC (central bank in China) has done more to stimulate their economy (to incentivize bank lending) and this morning, the ECB has come in with more easy money policies.  Both the Fed and ECB were pre-emptive shots.

Like 2016, the response from central banks has been aggressive and coordinated to ward off slowdown and/or a stock market destabilization.  That recipe worked well in 2016.  I suspect it will work well this year.

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Silicon Valley Is About To Dump Overvalued IPOs On The Investing Public

March 6, 5:00 pm EST

Yesterday we talked about the big IPO agenda for the year.

We have some big Silicon Valley “disrupters” set to go public this year, including Lyft, Uber, WeWork and Airbnb.

Remember, these companies emerged from a post-Great Recession world, where pension funds and sovereign wealth funds were flooding money into Silicon Valley, following the money and regulatory favor from the U.S. government.  Of the $800 billion fiscal stimulus response to the financial crisis, the Obama administration doled out $100 billion worth of funding and grants for “the discovery, development and implementation of various technologies.”  The money followed it, and the private market valuations soared.

Were they based on reality or hype and too much money chasing the dream of the next Facebook?

Let’s take a look today at how the big “disrupters” of the past two years have fared, after much anticipated IPOs.

Dropbox:  Dropbox was priced at $21 per share.  It started trading at over $28.  Today it trades at $22.

Spotify:  Priced at $165.90 per share.  It started trading at $164.  It currently trades at $146.

Snap: Priced at $17 per share.  It started trading at $22.  Today it trades at $9.90.

Nothing good for the average investor that picked up these shares when these stocks went public.

Who has gotten rich? The founders.

The founder of Dropbox is worth $2.3 billion.  His company lost half a billion dollars last year on $1.4 billion in revenue.  Revenue growth is slowing to a near mortal 25% growth rate – and losses are widening dramatically.

Spotify’s founder is now also worth about $2.3 billion.  Revenue growth is slowing too to unexciting levels, and the company is still losing money.

What about Snap?  The Snap founder is worth over $2 billion.  Snap lost $1.2 billion last year, on $1.1 billion in revenue. Revenue growth has gone from 600%, to 100%, to 43% last year.

The hyper-growth valuations are unlikely to get hyper-growth.  I suspect we might see the same with the roster of IPOs this year.

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