Wednesday, December 5, 2018

Stocks Dive - Do We Blame The Flattening Yield Curve Or Trump's "I Am Tariff Man" Jabber?

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Yield curve behavior since 1977  (from T. Rowe Price Investor Bulletin)
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Oldster Stock trader in a near fit on the NY stock exchange yesterday after stocks tank - when Dotard bragged: "I am Tariff Man!"

The Financial Times lead article yesterday was blunt in accounting for the major stock market selloff, traced to the yield curve dipping more than 10 basis points below its historical low since June, 2007.  As the FT report noted:

 "A swift turn in bank stocks saw Wall Street fall sharply after noon on Tuesday, while further falls for the tech names dragged the Nasdaq Composite back into correction territory. That comes against a backdrop of falling yields, as government bonds rally, and one key indicator - the yield curve - again started to signal low-growth or possibly recessionary economic conditions. "

Meanwhile, the WSJ take ('U.S. Bonds Gain As Stocks Sink', p. A1)  on yesterday's stock dive read as follows:

"U.S. government bond prices rose Tuesday, pushing the yield on 10-year Treasury notes further below 3%, as investors sought safer investments during the stock-market selloff.

The yield on the benchmark 10-year Treasury note fell for a sixth consecutive trading session, settling at 2.921%, from 2.990% Monday. The yield has fallen to its lowest level in almost three months after reaching a seven-year high of 3.232% on Nov. 8.

Yields, which fall when bond prices rise, declined along with stock prices as investors—including pensions, individuals and mutual funds—turned to less risky assets amid unsettled markets, analysts said. The rally in bonds intensified as major stock indexes extended losses during the trading session.
The fall in stocks—which sent the Dow Jones Industrial Average down nearly 800 points—erased Monday’s gains as skepticism grew about whether the trade truce between the U.S. and China will do more than temporarily stall the escalating rhetoric and tariffs from both sides.
---   The gap between yields on the two- and 10-year Treasury note yields narrowed to 0.110 percentage point Tuesday, the smallest difference since 2007. Investors closely watch the distance between the shorter- and longer-term yields because short-term rates have exceeded long-term ones before every recession since 1975, a phenomenon known as an inverted yield curve.

What is the yield curve and why does it matter? Why does its flattening strike fear into the investor's heart?  First, let's clear the air that one large component of the stock dive yesterday was simply that investors don't trust Trump to behave in relation to the artificial "90 day truce" on tariffs he set up with China's President Xi at the G 20 summit.  They aren't buying it because most are pretty sure Dotard will find some lame excuse to trash it and go back to his 25 % promised tariffs on another $200b worth of Chinese goods.  Hell, just before stocks started tanking yesterday it was Drumpf who took to Twitter and barked:

"President Xi and I want this deal to happen. But it probably will. But if not remember I am 'Tariff Man'"

Translated for  Wall Street: "I don't give a flying fudge stick about this deal, and I am just itching for a way to quash hit and hit 'em with more tariffs."

And look, by now President Xi Jinping has to know he is dealing with a dyspeptic toddler in a stage of  severe arrested development, who's also so unstable that no genuine deal is feasible. This is on account of the very nature of the man: a two-bit, lowlife Queens real estate crook and con man grifter.  A  thug at heart, whose folks had to dispatch him to a NY military school after cops caught him using his  'designer' switchblades on alley cats.  This is the loose cannon mutt we now have as resident.

Thus, I  believe the trade truce is merely a pause in ongoing trade hostilities and the main casualties will remain the Trumpie base,  who can't seem to slaver enough at Dotard's feet.  That's the nature of the beast, or at least this beast.

As regards the flattening yield curve - that also is a big worry.  As observed in the WSJ piece (see bottom of this post) :
"The gap two- and five-year yields inverted Tuesday, following Monday’s inversion of the spread between three- and five-year yields."

No photo description available. As I noted in previous posts on the issue, the U.S. Treasury yield curve - the spread between 2- and 10-year Treasury bond yields- has flattened sharply this year  but has not yet "inverted" - which most investors take as a sign of a looming recession. Specifically, recessions tend to occur once the "flat" yield curve becomes "inverted" - with short term (e.g. 2 -year)  bond rates higher than long term (e.g. 10 year) rates. As a recent T. Rowe Price Investor Bulletin notes (p. 4) this condition has transpired before each of the past nine recessions dating back to 1955.  Hence, while it isn't a 100% absolute predictor, it is a significant historical marker..

The T. Rowe warning - assuming one can take it as such - is (ibid.):

"The yield curve is not flat yet ...but it could be by next March if the Fed maintains its 0.25 percent per quarter pace of rate hikes and the 10-year Treasury continues to meet resistance above the 3.0 percent level.  Starting the historical average 16-month clock from the spring of 2019 would raise the specter of a major downturn by 2020."

Interestingly, this take also conforms with the one of Matt O'Brien writing in the WaPo ('Reasons There Really  Might Be A Recession In 2020').    O'Brien tags the "two big risks" today as: 1) the rising interest rates (which ought to also include the Fed cutting back on its QE policy, and 2) the difference between the government's 10-year and 2-year borrowing costs are beginning to flash yellow.

In other words, the yield curve is flattening . In O'Brien's explanation:

"When long term rates are lower than short term ones - what's known as an inverted yield curve- it's telling us that that markets think the Federal Reserve is going to have to stop raising rates and start cutting them in the near future."

Maybe O'Brien saw ahead to the NY Federal Reserve Chief's (John Williams)  comment yesterday that he "supports further rate hikes" - which unnerved the Street.  Anyway, O'Brien goes on to write that the ''good news is this hasn't happened yet, but the bad news is that it probably won't be long before it does."   But I am not so sure. If a recession is in the offing, the Fed would also know that if it leaves the existing rate too low (say relative to what is regarded by most Fed heads as the "neutral rate" - say 2.75%)  then there would be too little latitude left to lower rates when an actual recession hits. As I believe it will before the end of 2019. Why? Because all the Trumpies' borrowing  and debt will come home to roost- not to mention the upheaval from Dotard's trade war with President Xi.

What can savvy investors do? Stay tuned and keep monitoring the financial pages for signs of the inverted yield curve.  (Also watch out if a gov't shutdown occurs, again thanks to Dotard Donnie's imbecility and belligerence.)

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