foxex: Wall of Worry

The Market Sum | INVESTOPEDIA

Insight after the bell

By Caleb Silver, Editor in Chief

Monday's Headlines

1. Stocks lose traction as investors face a wall of worry

Markets Close

Dow
23,909.84 -0.36%

S&P
2,582.61 -0.53%

Nasdaq
6,905.92 -0.94%

VIX
19.07 +4.84%

INV Anxiety Index
100.91 Neutral

US 10-Yr Yield
2.71 +0.33%

You Might Be A Little Worried - I Get That

Stocks were under pressure out of the gate today as investors were digesting the realities of underwhelming earnings, weak economic data out of China and the continuing U.S. Government shutdown. The first two factors - earnings and China - are unavoidable. The shutdown is ludicrous, and now the longest in history.

As for earnings, Citigroup reported earnings in line with analysts expectations, but warned of weakness in its fixed income business. There has been a lot of concern about fixed income, or the credit market, as it is also known. Both government bonds and corporate bond yields have been under pressure for months as we have seen an inversion of the yield curve in some U.S. Treasuries. The 10-year U.S. Treasury Yield, arguably the most important U.S. bond given that so many loans are based off of it, entered a 'death cross', last week as James explains below.

Why it Matters

The corporate bond market, where companies go to raise money against their debt, now stands at over $9 trillion, according to the Securities Industry and Financial Markets Association. That's a 64% increase from a decade ago when the Federal Reserve lowered interest rates to nearly zero. The size is not as important as the credit quality of the companies issuing the bonds, which have been deteriorating as (but not because) real interest rates have been rising. Put another way, there is a growing concern that many companies that issued bonds to raise capital may not be able to pay back those loans.

Meanwhile the U.S. Treasury Dept., is having its own issues selling debt. Remember, the Treasury Dept. was a net buyer of debt coming out of the financial crisis up until last year. That stabilized the market. Now that it is back to its regular role of selling U.S. debt, the demand is weak. Read more on that here.

The chart below, from SIFMA, shows the extreme rise in long-term debt issuance across companies, governments and other asset backed securities. It's a $41 Trillion market, and corporations are 25% of it. We are keeping a close eye on this.

Earnings

We've written a lot about lowered earnings expectations on the horizon and how that has been one of the culprits of the extreme selloff we witnessed at the end of 2018. It's here. This week kicks off earnings season, beginning with banks like Citi and JPMorgan. Banks are a good proxy for the overall economy since most of them offer everything from lending to classic banking, trading to institutional and retail investing, and underwriting. When financial stocks are strong, the stock market typically follows. Financial stocks are weak right now, as evidenced by the 13% decline over the past year in the XLF ETF, which tracks banks and money managers. So we're keeping an eye on that, too.

Why it Matters

There is a school of thought that says that companies like to lower their earnings forecasts before they report their results, then surprise investors to the upside when they actually do. Given the volatility of late and the overall economic environment, I would not count on that as an investing strategy at this time. You can count on heavy volatility throughout this earnings season, however. Goldman Sachs charted the movement of stocks on the day they report their earnings and found an average implied move of 7% in one direction or another. A 7% move for a stock on any day is a lot. The fact that stocks are expected to make that big of a move on earnings day is a testament to the recent volatility in the market and the itchy-trigger fingers on traders' hands. This is the kind of market day traders love, but it is dangerous for long-term investors. If you zoom in on the chart below, you will see the last time implied volatility was this high was during the financial crisis. No wonder investors are hiding out in cash and money market funds. Data from the Investment Company Inst. shows that money market mutual funds topped $3 trillion in December, and added another $20 billion last week.

What's Next

The earnings parade will march on for the next 3-4 weeks. Buckle up.

Tuesday is a huge day for UK Prime Minister Theresa May and Brexit. The Brexit plan she has been backing goes up for a parliamentary vote tomorrow after several days of debate. Parliament has not been friendly to May, although she did survive a 'no confidence vote' last month. A key sticking point for May's plan is the issue of Northern Ireland, and how the UK and EU will deal with their only remaining shared border, should her plan go through.

If May's plan is rejected, she has three working days to come up with a Plan B.

We've laid out a good, but long primer on Brexit and the implications if it passes or fails, here.

The BBC does a great job of providing the day to day, blow by blow, activity around Brexit. Find that here.

Either way, circle March 29th, 2019 on your calendar. That's the day the UK plans to leave the EU, officially.

Chart of the Day: 10-Year Yield Confirms Death Cross

The yield on the 10-year treasury note hit what technical analysts call a 'death cross' last week, and the pattern was confirmed on Monday. A death cross is a chart pattern defined in technical analysis as the crossing of a shorter-term moving average below a longer-term moving average. Typically, the most common moving averages used in this pattern are the 50-day and 200-day moving averages. The death cross is usually considered an exceptionally bearish pattern, and has occurred relatively rarely on the 10-year yield in recent history. The last time it occurred was in June 2017.

What does this mean for markets and interest rates? Since November, interest rate expectations have been falling sharply as economic concerns have increased and the Federal Reserve has become increasingly dovish about further rate hikes in 2019 and beyond. The 10-year yield hit a double-top around 3.250% in October and November, when expectations of aggressive rate hikes by the Fed were still high. Those expectations have deteriorated significantly as worries over slowing economic growth and even a possible recession still loom. In the near-term, yields may continue to decline as investors remain nervous, market volatility stays elevated, and the Fed becomes increasingly cautious.