We will be closed in observance of Thanksgiving
on Thursday, November 28th and
Friday, November 29th
Enjoy Your Holiday!
We will be closed in observance of Thanksgiving
on Thursday, November 28th and
Friday, November 29th
Enjoy Your Holiday!
I have talked about this phenomenon before and must do it again today. All over the news recently is how the previously inverted yield curve is now no longer inverted.
Yield curve inversion is when short term Federal Funds Rate, set by the Federal Reserve, has a higher yield than longer term rates. The most common curve-inversion metric is the Fed Funds rate versus the 10-year Treasury bond. One can also make comparisons between the 30yr, 10yr, 5yr, 2yr and 1yr Treasury yields. Inversion is regarded as an indicator of a higher risk of recession in the near future.
The chart below shows, in blue, the spread between the US 10 year Treasury yield and the Fed Funds Rate. The orange is the Fed Funds rate, set by the Federal Reserve. Red is the 10-year Treasury.
We can see without a doubt that the past 3 recessions (grey bars) were preceded by a decline in the 10-year yield to BELOW the Fed Funds Rate. Longer term bonds carry higher rates of interest primarily due to inflation expectations. The natural state is to have the longest-term bonds pay more than shorter term bonds.
When the 10-year is below the Fed Funds rate, the curve is said to be inverted, as its expected longer-term rates are normally higher than short term rates (the Fed Funds rate is an overnight rate). The curve un-inverts when the 10-year yield goes back above the Fed Funds rate.
The financial media have spilled a lot of digital ink on this topic. When it first inverted, reports were based on a recession indicator. Now that it has normalized slightly, I’m seeing reports that the recession risk has passed.
The chart below clearly indicates that the past 3 recessions began as the curve un-inverted. Recessions are the grey vertical bars.
The process the last 3 times this has occurred was that; 1) market-driven yield on the 10-year bond went down, generally due to deteriorating economic conditions. 2) the 10-year gets below the Fed Funds rate (blue line under the 0% level), inversion. 3) The Fed begins to lower rates to stimulate the economy. It continues to lower rates basically until the recession is over (orange line). 4) The 10-year Treasury bond yield remains flat or vacillates some as the Fed lowers its Fed Funds rate below the Fed Funds rate, un-inverting.
The problem lays in that the Fed is doing the ‘un-inverting’, not market forces. Had the Fed left rates alone at 2.5% and the 10-year market-driven rate had gone up (due to increasing economic activity)—THAT would be healthy and a good sign for earnings and the economy.
It is important to remember that stock prices and the economy are only loosely tied together in the short term, stock prices can rise and remain elevated in the early stages of a recession. Also, it is possible that the curve inversion is falsely predicting a recession, however this indicator has a very high success rate.
Adam Waszkowski, CFA
November 3, 2019
After a week September, equity markets came back to life in October with the S&P 500 gaining about 2.2%, Euro Stoxx 600 up almost 6% (equal now to April ’19, but still 11% below all-time high from Jan 2018), emerging market stocks gained 4% (remain under April ’19 level, and about 20% below Jan 2018). Aggregate bond index was flat on the month, gold gained 2.5% but remains sideways over the past couple of months. Portfolios gained across the board, .75% to about 2% on the month. Our recently added individual stocks continue to do well supporting our core ETF holdings.
Stocks appear to be moving up out of the range we have seen the past several months on the hopes of a trade deal with China and that the current earnings recession is about to end.
Open Interest in gold futures has declined by about 20% as prices have gone sideways and media attention has waned. At the same time prices have gone sideways and appear to have consolidated enough to provide another base from which to stage another modest rally.
Market driven interest rates have climbed, fallen and climbed again, since August and are consolidating. With economic numbers (showing the recent past month) have begun to slow their decline (still contracting in durable good, manufacturing) the Fed is indicating less willingness to commit to additional rate cuts. If data remains ‘less-bad’ I don’t expect a rate cut in December.
Recently we’ve seen very low expectations in employment, earnings and economic data come in ‘less-bad’. Employment gains were expected at 75k (very weak) to 128k (middling, barely keeping pace with population growth); earnings decline for Q3 year over year at -1% (expected at -3%) and manufacturing PMI slip to 48.3, but greater than expected 47.8 (both indicate contraction). So, with data not being worse than feared appears to have given market participants confidence that this year may be similar to 2015/2016 and that this bout of weakness will pass.
Western economies grow with credit growth. In my October Observations, we see how China’s credit impulse impacts US economic data. China’s credit impulse has gone from declining to flat which I believe is the source of our no-longer-falling-but-still-weak economic data. The Fed restarted a form of QE in September putting in substantial liquidity (comparted to the drain previously) and should give rise to good data in December and January. If this is temporary remains to be seen.
The US dollar has broken down and may signal an end to its climb (and some decline) which should bode well for commodities which have been added to portfolios. Oil is on the sidelines still as its in the middle of its 12-, 6-, and 3-month ranges! We may also see (as mentioned previously) outperformance in ex-US equities (affirmative past 90 days).
Adam Waszkowski, CFA
October 8, 2019
Over the past 3, 12 and 18 months there has been a wide dispersion in the returns of various asset classes. US equites remain range-bound while ex-US, stocks continue to ebb. Risk-off assets like bonds and gold have done very well over the past year, while stocks vacillate. Interest rates continue to fall, and inflation expectations are subdued. Earnings growth for the third quarter are expected to be negative year over year, and likely zero growth for full year 2019. US economic data continues to be weak while Eurozone and Asia may be entering a recession. Below are the approximate returns over the 3-month, 12-month and 18-month time frames.
3 mos. 12 mos. 18 mos.
S&P500 1.7% 4.25% 13.5%
Russell 2000 (US small cap) -2.4% -8.9% .5%
Euro Stoxx 600 .8% -.5% -2.4%
Emerging stocks -4.2% -2% -14%
Gold 4% 23.1% 10.4%
Long-bond price (TLT) 8.1% 25.2% 21.8%
Aggregate Bond Index 2.3% 7.5% 9.6%
Economic data in the US continues to roll over. The chart below shows the top three inputs into the LEI (Leading Economic Indicator) as published by the Conference Board. Data continued to slow and is now in contraction in some areas like manufacturing. Payroll growth has declined significantly during 2019. These data points must reverse very soon otherwise we will undercut the 2015 slowdown and increase chances of a recession in the coming months.
We’ve been seeing risk-off assets outperform substantially in recent quarters under the pressure of slowing global economic data and lack of growth in earnings. More recently there are been reports of large-scale rotation from growth stocks (like Consumer Discretionary sector; XLY) to more value-oriented stocks (like Consumer Staples; XLP). Value has begun to outperform growth. While not completely uncommon, it is uncommon to see this while Consumer Confidence is very high. Recently I came across the chart below from Sentimenttrader.com which shows how rare this is.
Discretionary items are what people buy with ‘extra’ money, while Staples are what people need for everyday life. Defensive areas usually outperform only when consumers and investors are less confidence about the future. Only just after the market peak in 1969 (far left side) and the 2000 peak (center) confidence was high (survey results) while defensives were beginning to outperform cyclical stocks. If this rotation continues it may portend tough times for the general stock market.
Why might consumers be confident while investors are buying more defensive stocks over more cyclical stocks is a difficult question. Sentiment is often a lagging indicator. People feel good and optimistic after good things happen. The long string of employment growth and a long bull market has buoyed sentiment, perhaps so much that any contrary information is being discounted. A poor job report or two may change this outlook. But again, we are faced with an imminent need for very good economic data points to counteract current downtrends.
Credit Expansion (aka QE/liquidity/debt)
These two charts show how China’s credit impulse (QE/liquidity/Reserve Rate reductions etc.) have a lagged impact on US manufacturing. Coming out of the 2009 recession, China had the spigot wide open and we can see US PMI hit a high mark in early 2011. The Impulse was removed during 2010 which resulted in a decline in US PMI. The renewed impulses in mid-2012 and late 2015 helped create the rise in US PMI in 2013 and 2016. There is about a 6-9 month lag between an expansion in credit and its impact on the real economy.
Today we are seeing the impact of a lack of significant credit expansion which should continue Global economies appear to be completely reliant upon increasingly larger credit impulses to maintain growth. China has eased during calendar year 2019, but not as much in the past. Hopefully we will soon see better US PMI numbers to avoid outright recession in the very near term.
Update on the Yield Curve
We’re not hearing much on the Yield Curve lately. It remains inverted with the 10-year Treasury yield being lower than the 90-day T-bill rate. The 90-day bill and Fed Funds rate (set by the Federal Reserve) follow each other hand in glove. We can see market rates, the 10-year Treasury yield began to decline in earnest about a year ago. We can also see how the 90-day rate moved lower prior to the Fed lowering rates. It is clear that the Fed follows the market.
Current market expectations are that the Fed will lower its rate again in October by another 25 bps (.25%). I have showed in previous writings how the last two recessions began (the official dating) as the yield curve regained normalcy with the 10-year yield rising above the 90-day/Fed Funds rate by .33%.
If the Fed Funds rate decreases by .25%, from 1.75% to 1.5%, and the 10-year yield remains constant at 1.56%, the yield curve will un-invert and become positive. Further decreases will cause the spread to go above .33%. In 2007 the Fed lowered its rate enough (following the 90-day T-Bill) to get below the 10-year yield, resteepening/normalizing the curve again. This occurred August-October 2007, and the official dating (which was given to us November 28, 2008(!) that it started December 2007. Waiting for economic data regarding a recession, before reallocating one’s investments will always result in very poor returns
Adam Waszkowski, CFA
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October 1, 2019
In contrast to August, September has seen the S&P500 generally trend up, moving up from 2900 to 3020 (+4%) and now back to 2977, just under the July 3 level, for a gain of approx. 1% on the quarter. We are boxed between the 3000 and 2900 levels producing essentially flat or down equity markets over the past month and quarter. Portfolios are flat to slightly down on the month.
As indicated last month, gold’s (and bonds’) strong year to date gains through August brought media attention to these assets, which often can mean an end to a trend. Gold is down almost 2% for September and long treasury bond (TLT) off about 3%. Media attention has vanished towards gold alongside the weakness and attention drawn away to stocks’ attempts at new all-time highs.
Gold has either completed a run up, or this may just be a pause with another run to go. Over $1475/oz allows us to expect further gains after September’s consolidation.
In all, stock indexes have been very sideways for quite some time. The Dow is at 26928 now and was at 26570 at the January 2018 high. The lack of real progress is reminiscent of the 2015 flat market, which also was the last time we had an earnings recession, like today. A break to the upside should indicate substantial upside for stocks, but a break of the downside (about 2% lower than today) could see further 6% decline and still be in the range over the past 18 months. Mentioned In my Observations from January 2018, 10-20% swings are common in late stage bull markets and are likely to persist.
The S&P500 was at 2950 at the end of April. Today the S&P500 is at 2980, barely 1% net change over 5 months. Portfolios over that same time frame are up 1% to over 4% over the same time frame. Due to higher stock exposure, more aggressive portfolios lagged more conservative positioning over that time.
US economic data continues to be lackluster and growth continues to slow. China and Eurozone data are very poor, and the interconnectedness of global trade and finance are impacting the US.
Earnings remain in contraction, with earnings ‘growth’ now forecast to be -3% 2019 vs 2018.
Interbank lending had a significant problem in mid-September when overnight rates bank charge went from 2.5% (annualized) to 8%. To say this is extremely odd is to put it mildly. 99.5% of the time over the past 20 years, overnight rates stay within a quarter percent of the Fed Funds rate. The Fed has had to reopen emergency repo operations to add liquidity to banks for the first time since 2009. It is still unknown why banks were unwilling or unable to lend fully collateralized excess cash overnight.
The cannabis sector suffering from slowing growth in Canadian names and now the vaping hysteria has not been able to turn the corner and remains under severe pressure. I am in the process of fully exiting this area for the foreseeable future. Add to the list of mini bubbles: FAANG, Bitcoin, now Cannabis. We may see another 25% to 30% decline in this sector.
Adam Waszkowski, CFA
August has been a volatile month. Since August 2, the SP500 has seen 5 moves of 3-4% in both directions for a net, -3%, through today.
Gold, gold miners and long treasuries (TLT) continue to do well putting portfolios into the green for August. For August, gold +9%; miners +15%, TLT +11%. Prior to this almost 12 month run in these areas, it was commonly known that ‘gold is languishing”; and “rates will go up”. Now, its “gold hits 5-year highs”, and “rates seen to continue to fall”. Often by the time the media reports it widely, the trend is nearing completion.
As we approach Labor Day and the seasonally worst time of the year (Sept/Oct) I am watching for the SP500 to at least stay over 2850, and if we can get over 2940 it opens the door to climb further-but until then markets are under pressure. Small cap, international stocks are still well below their highs.
Recently it appears the when the US Dollar weakens, US stocks fall while ex-US are more stable. If the Fed continues to acknowledge further Fed funds rate cuts are likely, this can weigh on the Dollar—unless Europe et al jump ahead and push rates lower via more bond purchases. So, we may see relative outperformance from ex-US stocks.
Of the individual names purchased recently, one has bee sold out. IPHI was falling as the sector and general market was climbing, falling below a recent low in July. The loss was less than 5%. Cannabis remains under pressure. Curaleaf reported 200%+ gain in year over year revenue and today saw a drop of 9% at the open, followed by a 23% climb! This may mark a turn for the sector, but a reversal of these gains will see us abandon this sector in the near term.
The yield curve inversion has been big news. The 10-yr treasury yield crossed below the 2-yr yield on 8/13 and again on 8/27. While many other curve inversions have been occurring, this pair, coinciding with a 700 point down day on the Dow has gotten much attention. The past 3 recessions have occurred as this curve normalizes, that is un-inverts and re-steepens. I first pointed this out in my quarterly Observation piece January 2019.
Adam Waszkowski, CFA
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The Portfolio adheres to a simple strategy of investing in a weighted portfolio of 25 stocks consisting of sectors that the average consumer spends monies on each month. The Portfolio was up 4.49% for the second quarter, ahead of the S&P 500 benchmark by 19 basis points which was up 4.30% for the quarter.
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Yesterday, and this morning, the yield on the 30-yr Treasury bond made its all-time historic lows. This is extraordinary, especially given the vast amount of stimulus and low unemployment rate.
However, the news on the teevee seems to be harping on the Yield Curve Inversion regarding the 10-yr and 2-yr treasury rates. This is old news. Yield curve inversions have been everywhere over the past several months, yet barely a mention from the mainstream financial press. What I was expecting when I turned CNBC on late in the day was the never-before-seen rate on the 30-yr going below the Fed Funds effective rate. Additionally, the classic ‘inverted yield curve’ is when the 10yr treasury rate goes below the Fed Funds rate (which tracks closely to the 90-day t-bll), which almost occurred January 2019 and again in March. This inversion first took place May 23rd well into the stock market swoon that began on May 1.
Below is a chart of the Fed Funds rate, 2-,5-,7-, 10-, and 30-yr rates. In a normal environment the curve steepens from low short-term rates to higher long-term rates. Inflation expectations and time value of money are what drives this structure. So, when we see longer term rates move below shorter-term rates it is at a minimum, unusual. Analysts generally agree that when this normal structure changes, that changes in the economy and markets are afoot.
As you can see, yields have been falling since late summer 2018. This coincides with many data points (durable goods, autos, housing starts, etc.) that peaked and began to move down, indicating slower growth (still growing but slower and slower). It was the last rate hike (light blue line) where the structure began to invert, and March 2019 when rates began to invert strongly. There was very little reporting about the 2-/5-/7-yr rates going below the Fed rate. The reason behind the lack of attention is that the stock market was doing well. If stocks are up, any negative news is spun as “investors brush off X”. Ignoring information that doesn’t agree with what we see or would like to see is a form of confirmation bias.
In 2007 Bernanke raised rates right through the 10-yr yield to slow down the real estate bubble. Powell has raised rates and ended QE, making effective rise in the Fed rate much higher and faster than past, going against other central banks, leading to a very strong dollar. Powell’s statement in July and fair economic data today, make a rate cut in September unlikely, despite market rates screaming to lower.
As I have mentioned before in my Observations, while there will be a recession again in the US, when it occurs is difficult to predict. The last 3 recession were immediately preceded by a re-steepening of the yield curve. Stay tuned!
August 1, 2019
Portfolios saw modest gains in July, approximately 1-1.75%, while the SP500 saw similar gains. Small cap stocks moved up less than one-half percentage point. International equities dropped more than 2.5% with emerging markets trailing.
The long Treasury etf (TLT) was down most of the month, until the last day when it managed to finish flat for the month. Corporate bonds fared slightly worse with high yield underperforming corporates and treasury bonds. Lower interest rates most directly impact Treasuries as there is no risk of default, whereas on corporates and high yield, a change in the perception of the quality of the debt can push prices despite change in interest rates.
Gold was flat, giving up a percent on July 2, climbing into mid-month then giving it back to end flat for the month. Gold miners also dropped out of the gate, then climbed almost 11% before dropping yesterday and ending the month up almost 4%.
We are seeing some very constructive moves in the cannabis sector, after significant declines Curaleaf gained 10% in July and Charlottes Web almost 20%. The etf, MJ was sold out as its heavy weight in Canadian issues continues to wither.
All told, the general equity and bond markets were flat, international did poorly, precious metals were positive and other commodities (base metals, agriculture and oil) fared poorly.
Yesterday’s announcement by the Fed to reduce the overnight rate it lends to banks from 2.5% to 2.25% was expected. Prior to the announcement markets had priced in an 80% likelihood of a .25% cut and only a 20% change of a .5% cut. Over the past 12 months, growth in auto production, housing, durable goods orders have all been in a gradual decline. I and others have stated that the Fed had tightened far more quickly than in other periods. Some combination of slowing growth and recognition that the Fed tightened too much too quickly are what likely brought about today’s action. June’s economic numbers in some areas have shown an uptick. It may be a change in trend or just a pause in a continued decline, only time will tell.
Yesterday’s and today’s violent market reactions to ‘not promising more rate reductions’, and a very modest increase in tariffs on Chinese goods bely the fragile psyche of the market. Very poor economic numbers in the Eurozone and China (which together are about 25% greater than US GDP) are pulling the global economy down and parts of the US economy are beginning to feel it. After the sugar-high of corporate tax cuts, earnings in 2019 are looking to be about 2% lower than last year.
End-of-trade-war hopes, expectations of better earnings, the gift of cheaper money have been the drivers of stock prices this year. These ideas are getting denied or delayed and without some re-ignited positive expectations we may see the general stock market vacillate until there is more clarity. Or, these two days may just be a temper tantrum, showing the markets waning tolerance of slower global trade and dramatic difference between US interest rates and Europe. And after another day or two we may be off to the races again with the expectation that these issues will be resolved soon.
Adam Waszkowski, CFA
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With a Managed Account or SMA, it is disclosed to the investor what you own, letting you know in real time, each of the securities in your account, versus investing in a mutual fund, where you own units or shares without
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