foxex: Inverted

The Market Sum | Insight after the bell

By Caleb Silver, Editor in Chief

Friday's Headlines

Stocks Pounded on Economic Concerns and Yield Curve Inversion

Markets Close

Dow
25,502.32 -1.77%

S&P
2,800.71 -1.90%

Nasdaq
7,642.67 -2.50%

VIX
16.48 +20.91%

INV Anxiety Index
98.53 Low Anxiety

US 10-Yr Yield
2.455 -3.23%

Year-to-Date

Dow
25,502.32 +10.58%

S&P
2,800.71 +12.67%

Nasdaq
7,642.67 +16.07%

Russell 2000
1,505.92 +12.56%

Crude Oil
58.83 +28.58%

US 10-Yr Yield
2.455 -10.27%

Stocks Pounded

We haven't had a day like this in awhile...actually all year. U.S. markets had their worse daily decline in 2019. Investors ditched stocks as concerns about the economy and warning signals from the bond market sent buyers into Spring hiding.

In fact, investors have been pulling money out of stocks all week. According to Bank of America, $12.1 billion went into bonds, while $20.7 billion came out of equities. Just last week $14 billion went into stocks and it felt like we were on our way to record highs again.

Why the shift in sentiment?

For starters, the Federal Reserve sounded the alarm on an economic slowdown in the U.S. that will be more severe than forecast. That's a big part of the reason that they are not planning any interest rate hikes in 2019. That's typically good news for stocks, but as we explained on Wednesday, a weak economy is not good for anyone. This is manifesting in the bond market, specifically U.S Treasuries. Today, for the first time since 2007, the spread between the 3-month Treasury bill and the 10-year treasury bill turned negative, or "inverted".

This is how Investopedia defines an inverted yield curve:

"...An inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This type of yield curve is the rarest of the three main curve types and is considered to be a predictor of economic recession."

If you need to explain this to your mom or your teenage daughter (I have to do both) you can say that there is a bigger risk that you will not pay me back money I loan you for 3 months (hence the higher rate) than if I loan it to you for 10 years. Make sense?

The inversion of the 3-month US Treasury and the 10-year simply implies that there is an immediate and short-term weakness ahead for the economy, and investors should get paid a premium (yield) for loaning to the U.S. government (by buying U.S. Treasury bonds). (James walks us through the technical explanation in our daily chart, below.)

While this is all very concerning, we can't lose sight of the fact that stocks are up a lot for the year:

S&P 500 : +12%
Nasdaq: +15%
DJIA: +10%

Selloffs are tough to stomach, but let's put things in perspective. As Charlie Bilello, one of our favorite research analysts puts it,

"If you're panicking because of a 1-2% decline you have too much risk in your portfolio. The median intra-year drawdown in the S&P 500 since 1928 is 13%. There have been 23 corrections of less than 5% since March 2009."

Here's his chart:

What to Expect Next Week

Next week will be a busy one for economic reports, and the Fed's new dovish stance on interest rates will put many of them in perspective.

Monday

As we wrote yesterday, Apple will host the media for a product unveiling at its headquarters on Monday. It is expected to show off its new streaming service with original shows, an updated subscription news service for Apple News, and potentially a new iPad with a larger screen. Apple shares have been on a tear lately, so we'll see if the momentum continues on Monday.

Tuesday

We'll get a report on Consumer Confidence for March which should give us a pretty good picture of how healthy the U.S. consumer is feeling now that we are in the middle of tax filing season. A lot of taxpayers are realizing their returns are not what they thought they would be given the elimination of key deductions this year. Inflation is relatively tame, thanks to lower gas prices, but a shaky economy may rattle consumers more than we expect.

We'll also get the Case-Shiller Home Price Index, which measures average home prices in the biggest cities in America. That report will give us numbers from January (due to the government shutdown), so it's a couple months old. The world has changed a lot since then. Mortgage rates went lower this week, which will certainly bring more buyers to the market.

Wednesday

We'll get the trade deficit numbers for January (government shutdown, again), but it will tell us - in hindsight - just how much the increased tariffs on Chinese imports and U.S. exports impacted the overall deficit. U.S. and Chinese officials are allegedly working this weekend on finalizing the trade agreement, so we will hopefully get some new information on Monday.

Thursday

Thursday is all about the GDP revision for the fourth quarter of 2018. I know it's backward looking - all these reports are - but they do give us a reality check of how healthy the economy was compared to initial reports. We know the economy is slowing from 2.4% GDP growth to 2.1% growth this year, but was it as strong as the jobs market told us it was at the end of 2018? This chart from the Bureau of Economic Analysis shows how it has slowed over the past several quarters. Expect that to continue throughout 2019, but the big question is, "How bad will it be?"

Friday

Friday is another big day for consumer reports. We'll get the Consumer Spending report for February as well as the Consumer Sentiment Index for March. Remember that consumer spending accounts for more than 70% of GDP, so a healthy consumer can help the economy power through a slowdown, and put markets back on track after today's ugly slide.

Have a great weekend, everyone.

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Chart of the Day: Inverted Yield Curve Signals Potential Recession

On Friday, the 10-year and 3-month Treasury yields inverted for the first time since 2007. What does this mean? A yield curve is considered inverted when longer-term debt has a lower yield than shorter-term debt. When this happens, it's considered to be a foreboding (and reliable) signal of an upcoming recession. Though this signal has indeed been found to be reliable, the timing can be uncertain. The onset of such a recession can often range from several months to a couple of years after an inversion.

While the chart above clearly shows an inversion, it should be noted that when many economists and investors warn about inverted yield curves, they're often talking about the 10-year and 2-year yields, not the 10-year and 3-month. That said, the Federal Reserve sees the 10-year/3-month as the most reliable. Furthermore, even though the 10- and 2-year yields have not yet become inverted, the spread between the two has recently been the narrowest that it's been since 2007. This means that an impending inversion is a clear possibility.

Friday's yield curve inversion gave investors a dose of the jitters, as it helped to support increasing concerns about slowing global economic growth. Stocks took a nosedive on Friday, prompting the S&P 500 to fall 1.90%, its worst single day since early January. While the recession signal is quite clear, this shouldn't be a time to panic, yet. As noted, recessions historically don't happen immediately after yield curve inversions. And typically, stocks continue to rise after an inversion and before a recession actually hits.