“For now what the bond market is doing is signaling the chances of a recession are more likely than the chances of a renewal of the expansion,” said Tom Essaye, founder of Sevens Report Research. Click here to read the full article.
Tom Essaye quoted in ETF Trends. “There can be no clearer message than that to the Fed: Rates are too high. This is the bond market’s equivalent of a bullhorn screaming it in Powell’s face.” Click here to read the full article.
The bond market is once again sending a big fat warning sign about the US economy. “For stocks to continue to rally we need to see higher Treasury yields driven by hopes for better growth…” said Tom Essaye, editor of the Sevens Report.
The Federal Reserve has been on cruise control thus far in 2019 with respect to interest rate policy, opting to keep the federal funds rate untouched. However, the bond markets are screaming for a rate cut, according to Sevens Report Research. Click here to read the full article.
What’s in Today’s Report:
Futures are bouncing modestly following some hopeful comments by President Trump on U.S.-China trade.
Late yesterday President Trump made comments expressing optimism about an eventual U.S.-China trade deal that includes a solution for Huawei. No specifics or new details were provided, however.
Brexit entered a new phase as PM May announced she will resign on June 7th. But, until a “No Deal” becomes more likely, the global markets will continue ignore Brexit.
Today focus will be on Durable Goods Orders (E: -2.0%) and support at 2800 in the S&P 500. Yesterday that support level held and that’s a key number to watch going forward, as a violation of 2800 could open up an “air pocket” in stocks.
Regarding Durable Goods, it’d be nice if the data was solid, but it’s an April number so it won’t reflect activity following the flare up of U.S.-China trade tensions, and the headline is likely to be negatively skewed by cancellations for the 737, which started last month.
What’s in Today’s Report:
Futures are slightly higher following a positive U.S/China trade article and better than expected EU economic data.
EU Money Supply (M3) rose 4.1% vs. (E) 3.9%, delivering the first upside economic surprise in Europe in some time. And, while M3 isn’t exactly a widely followed report, at this point we’ll take what good data we can get from Europe.
On trade, a Reuters article stated Chinese officials have made new concessions on IP rights and tech transfers which represents an incrementally positive step, although other issues still need to be resolved before there is a an official deal.
Today there are some notable economic reports including Final Q4 ‘18 GDP (E: 2.2%), Jobless Claims (E: 225K), and Pending Home Sales (E: -1.0%) but none of them should move markets unless there are major surprises. Similarly, there are numerous Fed speakers, Quarles (7:15 a.m. ET), Clarida (9:30 a.m. ET), Bowman (10:00 a.m. ET), Bostic (11:30 a.m. ET) and Bullard (6:20 p.m. ET), but again they shouldn’t move markets, either.
So, we’ll be watching bond yields as the key to whether stocks can resume the rally. If bond yields (Treasury yields and Bund yields) can move higher today, then likely so can stocks
What’s in Today’s Report:
Futures are modestly higher thanks to reports that the U.S. and China are extremely close to a new trade deal.
The WSJ reported the U.S. and China are aiming to sign a new trade deal on March 27th that will include the removal of all tariffs, although the article cautioned it’s not a done deal at this point.
Economically, data was weak again as British Construction PMI (50.6 vs. (E) 52.5) and EuroZone PPI (3.0% vs. (E) 3.2%) missed estimates.
There are no economic reports today so focus will remain on U.S./China trade and any official confirmation (from the U.S. or Chinese government) of the positive articles that hit overnight.
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Import and Export Prices
• Import Prices rose 0.6% vs. (E) 0.4% in August
• Export Prices rose 0.6% vs. (E) 0.2% in August
Takeaway
A normally overlooked price report, Import and Export Prices came out yesterday and the release is worth mentioning. The headlines showed a decent upside beat in both import and export prices, which underscored the uptick in inflation we saw last week in several overseas CPI reports including China, Britain and India.
The reason this is worth pointing out is the bond market. Over the last several weeks, firming inflation overseas has become a recurring theme that has started to influence global fixed income markets, including Treasuries, pushing yields higher despite the fact that US inflation still remains very low.
Bottom line, yesterday’s Import and Export Prices report is showing the effects of both a weaker dollar, but also the fact that global inflation is beginning to edge higher.
From a macroeconomic standpoint that is encouraging for the reflation trade argument.
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For three months, we and other macro analysts have been warning that the bond market, via falling yields and a flattening yield curve, was sending a worrisome signal about future economic growth and inflation. And, that falling bond yields would act as a headwind on stocks.
Over that three months, the S&P 500 has moved steadily higher.
When will this chart matter? The S&P 500 (bar chart) has been diverging from yields (green line chart) for three-plus months. At some point, that gap must close.
Now, given that, it might seem like falling bonds yields don’t matter to stocks. However, decades of experience in this business combined with listening to experienced analysts and traders tells me that bond yields always matter to stocks… it’s just a question of “when” they matter.
Regarding when, most of us are working on a medium/longer-term time frame (i.e. quarters and years), so getting the bigger market signals right is more important than outperforming over a few weeks.
To that point, if bond yields do not reverse in the coming weeks/months, then I am quite sure that over the medium/longer term the stock market is in for a potentially significant pullback. Avoiding that pullback will be the key to multi-year outperformance.
So, the really important question is: “When will low bond yields matter?”
I believe the answer is: When investors realize bond yields are warning about a slowing economy, not lower inflation.
Right now, stock bulls are saying the drop in Treasury yields is just due to declining inflation—not because of potential slower economic growth.
Specifically, they’re pointing to statistical measures of inflation such as the CPI, PCE and the Price Deflator in GDP. Those measures of inflation are falling, which usu-ally means deflation (which is bad for stocks).
But, the bulls aren’t as concerned about falling statistical inflation because, in their view, inflation has changed. Specifically, there is a growing school of thought that in a technology-dominated world, the old inflation statistics (CPI/PCE/Price Deflator) no longer capture true inflation in the economy.
For instance, those inflation statistics are currently being driven down by 1) Lower oil, 2) The Amazon effect, where retail margins are relentless slashed, and 3) General technology making most everyday items cheaper and more efficient.
However, those price declines aren’t bad for the economy, and they don’t reflect the lack of consumer demand that usually accompanies falling prices. Technology and margin compression is making these prices fall, not an unwillingness of consumers to spend.
Meanwhile, asset and other forms of inflation are rising quickly. Over the past few years, home prices are up; rents are up, car prices are up, airfares are up, health insurance is up, tuition is up, the stock market is up and the bond market is up. So, the prices of all the things we “need” are up, but the prices of discretionary items (HD TVs, laptops, tablets, dishwashers, appliances) are down. Since CPI measures consumer goods heavily, inflation statistics are subdued.
Based on this logic, many investors aren’t sweating the decline in bond yields, because they believe, for now, that it’s just reflecting the decline in statistical inflation and not a future slowing of actual economic growth.
The key will be to recognize when investors begin to believe low bond yields reflect slower economic growth. That will be the time to get seriously defensive in asset allocations. Yet as Monday showed, with the market ignoring the soft Durable Goods report, we’re not there yet. But if this data doesn’t turn around, we will get there. Unfortunately, we don’t believe it’s different this time and if bond yields don’t start rising in the near term, then stocks will eventually suffer, like they’ve done virtually every time we’ve seen this type of stock/bond discrepancy.
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This is an excerpt from today’s Sevens Report—everything you need to know about the markets in your inbox by 7am, in 7 minutes or less.
One of the reasons I watch all asset classes so closely is because I’ve learned that other sectors often will confirm (or not confirm) a move in the stock market. Right now we are getting a pretty notable non-confirmation from the bond market.
Specifically, when stocks rally I like to see: 1) Bond yields rising, which reflects investors expecting greater economic growth and inflation (two stock positive events). 2) A steepening yield curve, which also reflects rising inflation expectations and increased demand for money via loans (something that has been sorely missing from this recovery). 3) I like to see “riskier” parts of the bond market, specifically junk bonds, rising (or at least holding flat) as investors show confidence in corporate America by lending money to riskier companies in search of greater yield (it’s an anecdotal risk-on signal).
Throughout Q4 2016, that’s exactly what we got. First, the yield on the 10-year Treasury rose from 1.54% in late September, to 2.40% at year end. Second, the yield curve steepened as the 10’s-2’s spread rose from 0.81% on Sept. 29 to 1.25% on Dec. 30. Finally, junk bonds were broadly flat during that period (although with notable volatility).
Since the start of 2017, the opposite has occurred. The 10 year started at 2.44% but now is sitting at 2.35%. The 10’s-2’s spread has decreased from 1.23% on Jan. 1 to 1.11% on Monday (the low for the year). Finally, junk bonds rallied through March with stocks, but have since given back some of those gains. If JNK (the junk bond ETF) breaks $36.19 that will be the first “lower low” of 2017, and a negative technical signal.
Point being, the bond market is reflecting an outlook that is comprised of slower growth, less inflation, and more general concern—which is almost the exact opposite of what we’re seeing in stocks right now.
To be clear, this non-confirmation isn’t a guaranteed death sentence for a stock rally. Bond markets gave non-confirmation signals consistently in 2015 when Europe was on the verge of deflation because of the flood of European money into Treasuries, which sent bonds higher and yields lower despite a stock rally. But, that’s not happening now.
So, the “gaps” in this environment are growing in size and number. The gap between political expectations and likely reality regarding tax cuts is as wide as it’s even been. The gap between hard and soft economic data continues to widen as sentiment indicators continue to surge. Now, the gap between bond market direction and stock market direction is widening.
Bottom line, the trend in stocks remains higher, but there are cracks appearing in the proverbial ledge stocks are standing on, and we better get some positive catalysts soon, otherwise we are in danger of a real pullback.
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