Markets
(New York)
Yes, the market is at or near all-time highs. Yes, the Fed is dovish, which is mildly bullish for markets (or very bullish if the economy stays in decent shape). However, equities are sending some strong warning signals too. In particular, two sectors which often act as bellwethers are showing that the market may be headed for a decline. Both small caps and transportation stocks have been struggling, a development usually associated with a market headed south. The sectors have declined at a rapid pace, and relative to the S&P 500 as a whole, are at their weakest point since 2009.
FINSUM: This is a signal similar in nature to the yield curve inversion. Is it material or just an aberration? Anyone’s guess.
(New York)
If you could time travel back to December, it would be hard to find anyone in the world that would have thought that six months later, ten-year Treasury yields would be back under 2%. The turnaround has been so stark and so dramatic, that it is hard to fathom. The yield is now at its lowest level since 2016, with investors fearful of the economy and anticipating several Fed rate cuts.
FINSUM: The big question is what this means. Consider that the yield curve has been inverted for over 90 days. This seems like a very clear recession signal, yet economic data continues to hold up.
(Washington)
There was a lot of anxiety yesterday about what the Fed might do. The big banks were taking the opposite side of markets, saying that the pace of rate cuts that investors expected were unrealistic. Then Fed chief Powell spoke and it became clear that markets were right, the Fed is completely dovish and has fallen in line with investor expectations. Powell signaled that rate cuts were on the immediate horizon, which has led markets to up their odds-making of a rate cut in July to 100%.
FINSUM: Powell was about as dovish as a central banker ever gets short of the middle of a crisis. For us this is quite an unusual situation—an economy doing well with both of the Fed’s dual targets being met, yet there is an undeniable sentiment towards cutting rates.
More...
(Beijing)
Bloomberg has published a very interesting article arguing that China’s economy and financial system might be on the edge of implosion. The publication mentions that the government’s bailout of Baoshang Bank last month has put money markets on edge, and for the first time, short-term lending between big institutions has started to freeze up. For the first time in decades, lenders are facing the prospect of defaults and haircuts on loans to other financial institutions. This has led funding costs for companies to shoot higher.
FINSUM: As is the norm with China, we have little direct insight into this. However, if you take a step back and look at the overall pressure on the economy from the trade war and combine it with the data above, it does sound like something very nasty could be brewing.
(Chicago)
Small caps are an interesting consideration right now. Ever since Trump’s election, they have had a general stimulus behind them from the widespread ethos of protectionism. Now, though, that push looks bigger than ever because of the trade war, meaning small caps might have smooth sailing. The problem is that it is hard to find the best small caps because of a lack of coverage by analysts and a weak online presence by many of them. With that in mind, Barron’s has some suggestions for how find good investments in the area, including joining online small cap communities (like Equity.guru and Small Cap Discoveries) and leveraging online discovery tools, like TMX Matrix, CEO.ca, and VRify.
FINSUM: A lot of alpha can be found in small caps simply through hard work and research. It is one of the areas of the equity markets where EMH theory is truly crap and knowledge advantages predominate.
(New York)
Whether investors like it or not, a recession is coming. One of the key indicators is for a yield curve inversion to last 90 days or more. If it does so, a recession is highly likely in the next 12-18 months. Well, the first point of inversion began in March and we just crossed the 90-day threshold, which means that the strongest indicator of recession has just been triggered. Here are some tips to prepare: clear out garbage holdings from your portfolio (e.g. the stock tip from your brother in law six months ago), set aside cash and come up with a plan to buy stocks when certain thresholds are hit (e.g. a 25% decline in key indexes), pay down debt (it might not be this easy to do so again for awhile).
FINSUM: For all the talk we have heard over the last year about “this time is different”, the reality is that the strongest recession indicator known has just been triggered.