Posts tagged ‘inverted yield curve’

Chinese Checkers or Chess?

chess

There’s been a high stakes economic game of trade going on between the United States and China, but it’s unclear what actual game is being played or what the rules are? Is it Chinese checkers, chess, or some other game?

Currently, the rules of the U.S.-China trade war game are continually changing. Most recently, the U.S. has implemented 15% in added tariffs (on approximately $125 billion in Chinese consumer imports) on September 1st. The president and his administration appreciate the significance of trade negotiations, especially as it relates to his second term reelection campaign, which is beginning to swing into full gear. However, game enthusiasts also understand you can’t win or truly play a game, if you don’t know the rules? In that same vein, investors have been confused about the U.S.-China trade game as the president’s Twitter account has been blowing up with tariff threats and trade discussion updates. As a negotiating tactic, the current unpredictable trade talks spearheaded by the Trump administration have been keeping investors guessing whether there will be a successful deal payoff. Until then, market participants have been sitting on the sidelines watching the stock market volatility unfold, one tweet at a time.

Here’s what the president has planned for other tariffs:

  • October 1: Tariffs on $250 billion in Chinese goods rise to 30%.
  • November 17: Europe auto tariff deadline.
  • December 15: 15% tariffs on $160 billion in Chinese goods.

This uncertain game translated into all the major stock market averages vacillating to an eventual decline last month, with a price chart resembling a cardiogram. More specifically, after bouncing around wildly, the S&P 500 decreased -1.8% last month (see chart below), the Dow Jones Industrial Average dropped -1.7%, and the tech-heavy Nasdaq fell -2.6%.

sp aug

Politically, there is bipartisan support to establish new trade rules and there is acknowledgement that China has been cheating and breaking trade rules for decades. The consensus among most constituencies is especially clear as it relates to Chinese theft of our intellectual property, forced technology transfer, and barriers for U.S. companies to invest in China.

Beyond trade talks, China has been stirring the geopolitical pot through its involvement in the political instability occurring in Hong Kong, which is a Special Administrative Region (SAR) of China. For over five months Hong Kong has had to deal with mass demonstration and clashes with police primarily over a proposed extradition bill that Hong Kong people fear would give mainland China control and jurisdiction over the region. Time will tell whether the protests will allow Hong Kong to remain relatively independent, or the Chinese Communist party will eventually lose patience and use an authoritarian response to the protesters.

Inverted Yield Curve: Fed No Longer Slamming Breaks in Front of Feared Recession

Another issue contributing to recent financial market volatility has been the so-called “inverted yield curve.” Typically, an economic recession has been caused by the Federal Reserve slamming the breaks on an overheated economy by raising short-term interest rates (Federal Funds target rate). Historically, as short-term rates rise and increase borrowing costs (i.e., slow down economic activity), long-term interest rates eventually fall amid expected weak economic activity. When declining long-term interest rates fall below short-term interest rates…voila, you have an inverted yield curve. Why is this scary? Ever since World War II, history has informed us that whenever this phenomenon has occurred, this dynamic has been a great predictor for a looming recession.

What’s different this time? Unlike the past, is it possible the next recession can be averted or delayed? One major difference is the explosion in negative interest rate yielding bonds now reaching $17 trillion.

neg bonds

Yes, you read that correctly, investors are lining up in droves for guaranteed losses – if these bonds are held until maturity. This widespread perception as a move to perceived safety has not protected the U.S. from the global rate anchor sinking our long-term interest rates. United States interest rates have not turned negative (yet?), but rates have fallen by more than half over the last 10 months from +3.24% to +1.51% on the 10-Year Treasury Note. Will this stimulate businesses to borrow and consumers to buy homes (i.e., through lower cost mortgages), or are these negative rates a sign of a massive global slowdown? The debate continues, but in the meantime, I’m going to take advantage of a 0%-interest rate loan to buy me an 85″ big screen television for my new home!

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (September 3, 2019). Subscribe on the right side of the page for the complete text.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

September 4, 2019 at 3:51 pm Leave a comment

Have Peripheral Colds Caused a U.S. Recession Flu?

tissue-box-1420439

At the trough of the recent correction, which was underscored by a brief but sharp -1,100 point drop in the Dow Jones Industrial Average, the Dow had temporarily corrected by -16.2% from its peak in May, earlier this year. Whether we retest or break below the 15,370 level again is debatable, but with the Dow almost reaching “bear market” (-20%) territory, it begs the question of whether the U.S. has caught a recessionary flu from the ill international markets’ colds?

Certainly, several factors have investors concerned about a potential recession, including the following: slowing growth and financial market instability in China; contraction of -0.4% in Japan’s Q2 GDP growth; and turmoil in emerging markets like Russia and Brazil. With stock prices down more than double digits, it appears investors factored in a significant chance of a recession occurring. Although the Tech Bubble of 2000 and generational Great Recession of 2008-2009 were no ordinary recessions, your more garden variety recessions like the 1980 and 1990 recessions resulted in peak to trough declines in the Dow Jones Industrial Average of -20.5% and -22.5%, respectively.

In other words, with the Dow recently down -16.2% in three months, investors were awfully close to factoring in a full blown U.S. recession.  Should this be the case? In answering this question, one must certainly understand the stock market is a predicting or discounting mechanism. However, if we pull out our economic thermometers, right now there are no definitive indicators sending us to the recessionary doctor’s office. Here are a number of the indicators to review.

Yield Curve Indicator

For starters, let’s take a look at the yield curve. Traditionally, in a normally expanding economy, we would normally expect inflationary expectations and a term premium for holding longer maturity bonds to equate to a positively shaped yield curve (e.g., shorter term 2-Year Treasuries with interest rates lower than 30-Year Treasuries). Interestingly, historically an inverted yield curve (shorter term interest rates are higher than longer term rates) has been an excellent leading indicator and warning signal for unhealthy stock market conditions forthcoming.

As you can see in the charts below, before the two preceding recessions, in the years 2000 and 2007, we experienced an inverted yield curve that served as a tremendous warning signal in advance of significant downdrafts in stock prices. If you fast forward to today, the slope of the yield curve is fairly steeply sloped – nowhere close to inverted. When the yield curve flattens meaningfully, I will become much more cautious.

Inverted Yield Curve 8-25-15

The Oil Price Indicator

There is substantial interest and focus on the recessionary conditions in the energy sector, and more specifically the high yield (junk bond) issuers that could suffer. It is true that high yield energy credit spreads have widened, but typically this sector’s pain has been the economy’s gain, and vice versa. The chart below shows that the gray shaded recessionary time periods have classically been preceded by spikes upward in oil prices. As you know, we currently are experiencing the opposite trend. Over the last 12 months, WTI oil prices have been chopped by more than half to $45 per barrel. This is effectively a massive tax for consumers, which should help support the economy.

Source: MacroTrends.Net

Source: MacroTrends.Net

 

Other Macro Statistics

Toward the top of any recession-causing, fear factor list right now is China. Slowing economic growth and an unstable Shanghai stock market has investors nervously biting their nails. Although China is the 2nd largest global economy behind the U.S., China still only accounts for about 15% of overall global economic activity, and U.S. exports to the region only account for about 0.7% of our GDP, according to veteran Value investor Bill Nygren. If on top of the China concern you layer a fairly strong U.S. labor market, an improving housing market (albeit slowly), and a recently revised higher GDP statistics, you could probably agree the economic dashboard is not signaling bright red flashing lights.

There is never a shortage of concerns to worry about, including most recently the slowing growth and stock market turbulence in China. While volatility may be implying sickness and international markets may be reaching for the Kleenex box, the yield curve, oil prices, and other macroeconomic indicators are signaling the outlook for U.S. stock remains relatively healthy.

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) , but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

August 30, 2015 at 12:20 am Leave a comment

Will Rising Rates Murder Market?

China Executes Wall Street Solution

After an obituary of Mark Twain had been mistakenly published in the United States, Twain sent a cable from London stating, “The reports of my death have been greatly exaggerated.” Similar reports about the death of the stock market have been prematurely published as well. If you were to listen to the talking heads on TV or other self-proclaimed media pundits, the prevailing opinion is that rising interest rates will murder the stock market. In reality, the benchmark 10-Year Treasury Note has risen a whopping 0.23% so far this year. Could this be a start of a more prolonged increase in interest rates? It is certainly possible. Most investors have a very short memory because we have seen this movie before. It was just two short years ago that we witnessed a near doubling of 10-Year Treasury yields exploding from 1.76% to 3.03% in 2013. Did the stock market crater? In fact, quite the contrary. The S&P 500 index catapulted higher by a whopping +30%.

Even if we go back a litter further in recent history, interest rates were quite a bit higher. For example in early 2010, 10-Year Treasury yields breached 4.0%. Where was the Dow Jones Industrial index then? A mere 11,000 vs 17,850 today. Or in other words, when interest rates were significantly higher than today’s 2.40% yield, the stock market managed to climb +62% higher. Not too shabby, eh? As I have talked about in the past (see Don’t Be a Fool, Follow the Stool), there are other factors besides interest rates that are contributing to positive stock returns – primarily profits, valuations, and sentiment are the other key factors in determining stock prices. Suffice it to say, over the last five years, stocks have survived quite well in the face of multiple interest rate spikes; the 2013 “Taper Tantrum”; and the subsequent completion of quantitative easing – QE (see chart below).

Underlying Chart: Yahoo Finance!

Underlying Chart: Yahoo Finance!

Yield Curve on the Side of Bulls

Despite the trepidation over a series of potential Fed rate hikes, stocks continue to grind higher. If the fears are based on the expectation of a slowing economy on the horizon, then we would generally see two things happening. First, rising short-term interest rates would cause the yield curve to flatten, and then secondly, the yield curve would invert (typically a leading indicator for a recession). Currently, there are no signs of flattening or inverting. Actually, the recent better than expected jobs report for May (280,000 jobs added vs. estimate of 226,000) created a steeper yield curve – long-term interest rates increased more than short-term interest rates. Just as I wrote in 2009 about the recovery (see Steepening Yield Curve Recovery), right now the bond market is flashing recovery…not slowdown.

In the face of the mini-interest rate spike, bank stocks are also signaling economic recovery – evidenced by the 2.75% surge in the KBW Bank Index (KBX) last week. If there were signs of dark clouds on the horizon, a flattening yield curve would squeeze bank net interest margins and profits, which ultimately would send bank investors to the exit. That phenomenon will eventually happen later in the economic cycle, but right now investors are voting in the opposite direction with their dollars.

The media, economists, strategists, and other nervous onlookers will continue fretting over the Federal Reserve’s eventual rate increases. As long as dovish Janet Yellen is at the helm of the Fed, future rate increases will be measured, and rather than murdering the stock market, the policies will merely reflect a removal of the economy from artificial life support.

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on ICContact page.

June 6, 2015 at 7:53 pm Leave a comment


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