@theMarket: Interest Rates and Stock Market
After years and years of historically low-interest rates both here and abroad, stock investors are suddenly paying attention to the day-to-day movements of the world's bond markets. They may be getting a little too obsessive for their own good.
This week, the 10-year Treasury note and the equity averages moved hand in hand. As the yield on the U.S. Treasury moved higher, stocks moved lower. As the yield fell, stocks gained ground. This change in behavior is causing a great deal of needless volatility but I believe it is all part of the "normalization" process.
That is a term coined by investors to explain what happens when our central banks begin to back off the last ten years' worth of monetary stimulus and let the markets begin to dictate the level of interest rates. Now, historically, bond and stock holders have had a symbiotic relationship.
As interest rates rise, stock holders would take account of the rising yield on bonds and compare it to what they can get in the stock market. If they deem that bonds are a better deal than stocks, they sell equities and buy bonds. Usually, investors take into account the longevity of these investments -- one, five, seven, ten, twenty or thirty years, while what happens to yields on a day-to-day basis does not tend to move stocks. But these are not normal times.
The controversial but largely successful actions of the world's central banks to stave off a second global depression brought on by the U.S. financial crisis is now being unwound. Since there were no precedents for the Fed's massive market "save" over the past decade, there is no surety that reversing the process will work without tipping us into some unforeseen calamity.
Remember too, that we now have an entire generation of financial sector players from retail brokers to institutional proprietary traders that have never experienced a rising interest rate environment. It has been almost 45 years since interest rates topped out during the Jimmy Carter years. Since then, rates have fallen lower and lower until quite recently.
At the same time, the wide spread use of algorithms, computer-driven trading and the like has largely replaced human thought and behavior in over 70 percent of daily trading volume. These computers are driven by software programs created by extremely young and unseasoned "quants" that simply look at numbers. They instruct their machines to sell if "X" price falls or rises by a certain amount.
They have neither context nor history to adjust their programs for a rising interest rate environment, so they treat bonds just like they were stocks. These technicians are running around building "models" to trade these short-term blips in bond movements, while trying to figure out their impact on individual stocks and indexes. There is no doubt in my mind that they will succeed. The problem is that bonds are not stocks.
Unlike the majority of stocks today, bonds are meant to be held, sometimes, until they mature (which can be as much as 30 years). Daily price movements are simply "noise" in the grand scheme of things in the bond world. But, today, young Turks act and trade like a 4-5 basis point move in bond yields will mean that the trillions of dollars invested in these instruments will be sold or bought in the next minute or so.
For you and me, what this development will provide is another reason why daily and weekly moves in the equity markets will have little to do with reality. The day's stock market results will simply be a reflection of a schoolyard full of little boys and girls playing with their toys. Some will make money doing it, while others will lose.
As for the markets, this week I expected them to pull back some. They did. During the last four days, stocks traded up and down in huge intra-day moves. On Tuesday alone, the Dow gained over three hundred points, dropped almost the same amount, before gaining half of it back. This kind of volatility tells me this consolidation period may not be over. We could still see a little more damage in the very short term, but overall, I am still convinced we are going higher and fairly soon.
@theMarket: Markets Have Best Week in Five Years
Stocks have had what is called a "V" shaped recovery this week. The indexes climbed every day at least one percent or more. Will it continue or ...
It wouldn't surprise me if stocks took a breather about now. A bout of profit-taking after the stupendous come-back we have had would be entirely reasonable. If the S&P 500 Index, for example, fell back 2-3 percent over the next week or so that would be healthy.
Remember, we are still in that period of the markets where investors are driven by the fear of missing out. As interest rates continue to climb and bond investors experience losses, the natural thing would be to sell bonds and buy equities.
In a lesson in reverse psychology, investors over the past week have talked themselves into believing that higher rates and a pick-up in inflation is actually good for the markets. Last week that same set of variables spelt doom for the stock market.
For me, the pullback was part of the natural rhythm of the equities market. Expect more of the same as the year goes by. However, these market dips will be supported by the accelerating growth of the global economy. That growth should climb this year to about 3.7 percent, while the U.S. economy should grow by almost 3 percent. We will also see inflation begin to climb to a 2.5 percent rate (give or take), which is higher than we have seen for many years.
The market is not wrong when they say a little inflation can be good for the economy. Everything is good in moderation. It is sudden spikes, whether in interest rates or inflation, that unsettles the market.
Since prior to the Republican tax cut, I have been saying that the danger would be that the tax cut really did what the president promised: increase investment and boost employment. If, on the other hand, the $1.5 trillion was simply a mass redistribution of wealth out of the pockets of Main Street and into the coffers of corporations and the rich then the stock market has little to worry about.
The money will simply be used to buy back stock and increase dividends. Since 84 percent of all stocks are owned by the wealthy (including Trump and almost all senators and congressmen), not only will these beneficiaries gain on a lower tax rate, but their investments will also gain.
As for the economy, it will do quite nicely without the additional fiscal stimulus. Unemployment is already approaching historical lows. So, from an economic point of view, the tax cut was eight years too late and is a needless addition to an already-huge government deficit.
So far the evidence points to the tax cut as a redistribution of wealth. Since the tax cut announcement, corporate buybacks have gone through the roof. Year to date, (and we are only in February) the amount totals $170.8 billion (17 percent of the tax cut) versus $75.7 billion for all of last year.
As for investing the tax cut into plant, equipment, and new jobs, well, 70 percent of corporations polled have no intention of investing the money, while the other 30 percent had plans to invest anyway prior to the new tax cut.
The final and most recent fiscal spending proposal on the nation's infrastructure announced this week is much-needed. However, the scheme, as presented, would mean the federal government would put in "seed money" of $250 billion, while the states and private sector would put in $750 billion.
Given that the tax cut was an enormous economic blow to states that have their own income tax, asking them to now ante up $750 billion for much-needed infrastructure repairs is the height of lunacy. Of course, Trump knows this all too well, but it gives him an out to blame the states for not doing their fair share when his proposal goes belly-up.
As for the markets, remain invested. Increased volatility is no excuse to sell, only a reason not to look at your portfolio every day or week. Remember that the more red you see in your portfolio on any given day, the higher the probability that you will sell at the exact wrong moment.
@theMarket: Higher Wages Clobber Markets
@theMarket: Higher Wages Clobber Markets
Gains in a worker's paycheck are supposed to be a good thing, right? It means they can spend more, which contributes to growth in the economy, and maybe have a happier life. If all of that is true, why has the stock market swooned in response to Friday's labor report?
It's simple really. The non-farm payrolls report was another upside surprise. The nation gained 200,000 jobs in January, which is better than the 180,000 we expected. While the official unemployment remained at 4.1 percent for the fourth straight month, it was the growth in wages that surprised the market most.
Hourly wages rose 0.3 percent over the prior month. That brings the year-over–year wage gains to 2.9 percent versus last year. That's the best wage gain news since 2009. However, what may be good for workers, may not be good for the stock market and here's why.
The labor market is tight. There are thousands of jobs out there that are unfilled and that number is mounting. Now, what happens when you need a skilled worker and can't find one? You have to raise wages and woo someone else's worker to you. Right now, the construction and food services areas are feeling the pinch. In those areas, wages have spiked by as much as 4 percent.
Since both I and the country's central bank use wage growth as an important gauge of future inflation, a rapid increase in hourly compensation could force the Fed to raise interest rates higher and faster than investors expected (in order to head off a spike in inflation before it happens).
As we entered 2018, investors were not discounting higher inflation. Instead, they have betting on moderate GDP growth, a continuation of modest rate hikes throughout the year by the Fed, and robust earnings growth.
And then Congress and the president passed tax reform.
Ask yourself this question: if President Trump is correct and the tax cut is going to mean American corporations will be spending that $1.5 trillion in tax savings on investment, while hiring new skilled workers at higher wages, what do you think is going to happen to wage growth?
As I have said before, we did not need a tax cut. The jobs market was already tight (as we can see in the numbers today). The economy did not need to grow any faster than it already was. The time to have passed a tax cut of this size was in the Obama years when the Fed was begging Congress to help stimulate the economy. Instead, Congress refused, arguing that it would balloon the deficit, something the GOP was steadfastly against. Instead, Republicans insisted that spending should be cut, which it was. The result: years of slow growth, misery and high unemployment.
Fast forward to today. The tax cut is blowing up the U.S. deficit as a result of the Republicans change of heart towards deficits (go figure). This week's U.S. Treasury bond auction revealed that the Treasury is going to have to sell much more debt in order to fund this tax cut-driven deficit. In the bond market, the more debt the nation sells, the more interest bond buyers are going to demand. This will apply even more pressure to the upward path of interest rates.
It is already happening. Since the tax cut passage, the U.S. benchmark interest rate, the 10-year bond, has spiked past 2.70 percent (today it is trading at 2.85 percent). Many bond players believe if the ten-year cracks 3 percent, the stock market is going to have a big correction. By the way, the thirty-year U.S. Treasury bond has just topped 3 percent, so you see where this is going.
Readers may recall my distinct unhappiness at this tax reform. Over several weeks, I tried to warn readers that this tax cut was going to be a disaster. Those in the Trump camp discounted my columns, sending me hate mail instead. Partisans on the other side simply cried all the way to the bank as the stock market roared higher in January.
Okay, so now what? It is not the end of the world. Instead, these fears of higher rates, spiking inflation, etc. are overblown for now, since we do not have enough data to determine what will unfold as the year progresses. Right now, these events are simply an excuse the markets needed to pull back. Something I have said is long overdue. That is healthy. How far down? I am expecting a 5-6 percent pullback overall before the market resumes its upward trend.
Remember, I have said that if the tax cut is simply a "thank you" from the Republican Party and the president to business and the wealthiest one percent of taxpayers for their 2017 campaign contributions, than it is simply politics as usual and no harm done.
If companies use the tax windfall to buy back shares, pay bigger dividends, and reward their CEOs, that helps the stock market, but not the economy or its workers. Inflation will increase, but at a modest pace, and the Fed will continue its program of gradually tightening, instead of jacking rates up quickly and driving the country into recession. We won't know which way this will play out until the spring. In the meantime, hang in there and hope that the tax cut was simply a payoff and tool to buy votes in November's elections.
@theMarket: Bulls Barrel Through Another Week
Better quarterly earnings trumped concerns of a declining greenback this week sending all the U.S. stock averages to yet more record highs. There appears to be no end in sight for this continued "melt-up" in the markets.
Over in Davos, Switzerland, President Donald Trump addressed the annual World Economic Forum. For the most part, it was a classic display of "Trumpisms"— MAGA, unfair trading partners, historic stock market. His "ain't American grand again, thanks to me" message failed to impress most of his foreign audience although his supporters were ecstatic over his speech. But whether you love him, or hate him, "The Donald" never fails to make headlines.
Steve Mnuchin, the administration's treasury secretary, was also at Davos. He managed to sink the dollar by over 2 percent on Wednesday, simply by failing to toe the line of former U.S. officials. The mantra of past secretaries had always been a strong dollar is good for America. Instead, Munchin, when asked about the weakening dollar, commented that short-term gyrations in the dollar did not concern him.
That's all the media and currency traders needed to hear. The dollar tanked, commodities roared, and news stories were circulating that U.S. currency policy had changed. By Thursday, Trump and his damage-control team went into action, denying all of the above and that the dollar would "become stronger and stronger." Mnuchin later insisted he had been misinterpreted and that a strong dollar was in the best interests of our country.
The greenback played yo-yo for the rest of the week. Down, up, down and by Friday back to the same levels it had been before the controversy. To be fair, Mnuchin was just telling it like it is. The truth is that no country's treasury secretary cares the least bit about the short-term meanderings of their country's currency, as long as those movements are within an acceptable range. To me, it was refreshing to hear someone acknowledge the facts of currency life, but what do I know?
The dollar's recent decline was triggered when Former Fed Chairwoman, Janet Yellen, mentioned that inflation was weak and might continue to be so. That set off some speculation that the Feds' intent to hike rates further might change, which would keep U.S. rates low. In addition, other central banks have recently signaled their intent to re-examine their monetary stimulus programs that could mean higher rates abroad.
Between the possibility of higher interest rates overseas, plus stronger global growth prospects elsewhere, investors are realizing that there are places besides the U.S. to put your money. Selling some green-backs and buying Euros or Yen-denominated stocks might make sense. Stocks worldwide had another great week as a result.
As for the market, overall, we are beginning to see a bit more volatility. By itself, that is not a bad thing, because the stock market is supposed to be volatile, and I suspect that may continue. At the same time, there is an overwhelming feeling out there that the market is living on borrowed time. With investor sentiment registering about 12 percent bears, many strategists are promising it is not "if" but "when" that pullback will occur. They are probably right. But before you begin thinking that you can time this market take note. The odds that you or me can get it right this time, meaning picking the top (and picking the bottom to get back in) is no better than winning the lottery.
@theMarket: Melt-Up Continues
It's been the best two weeks for the U.S. markets in decades. Investors seemingly can't get enough stocks in their portfolios, no matter how high the indexes climb. Ain't it grand?
Over the past few weeks, I have explained in detail that the stock market is in "melt-up" mode. You may think it's crazy, or that the gains are a result of excessive exuberance. You may even be sitting there with your arms crossed, pointing your finger at me and predicting this is all going to end badly for investors. That's fine, provide as many opinions as you like, but stay invested in the meantime.
Some ask me how you can have the U.S. dollar declining, while interest rates and stocks climb at the same time. Then there are the commodities — gold, basic materials, mines and metals — all moving up with stocks. Is there, in fact, anything except bond prices that are down?
Some of the movements can be explained by expectations that inflation will be rising in the future, based on the added stimulus of the Republican tax reform. The rise in interest rates anticipates what the Fed might do as a result of rising inflation (raise rates faster than expected). The lower dollar may also signify that bond investors may be able to get a better return on their money by investing in foreign markets outside the U.S.
Of course, all of the above trends can reverse on a dime next week, since no one really knows what impact the tax cuts will actually have on the economy. The interesting thing I have noticed since the beginning of the year has been how opinions on what is in store for the markets this year seems to have solidified.
In one corner, we have the doomsayers. The tax cut was unnecessary and will screw up the Fed's carefully planned interest rate model of gradually raising rates and reducing bond purchases. They fear that rates will need to rise faster to head off the inflationary impact of tax cuts. The markets will collapse as a result and the second half of the year is not going to be pretty.
No, no, say the Trumpsters and their followers. The tax cuts are going to "Make America Great Again." Jobs will be plentiful, GDP will grow even faster (by 3 percent or more), that earnings will accelerate, both as a result of huge tax savings, as well as by an ever-growing economy. As for inflation, well, it seems to be behaving itself thus far, so why worry about it until we have to?
At our firm, we pride ourselves on a contrarian outlook. We go left when others go right and vice versa. As such, we like to follow investor sentiment as it pertains to the stock market. The recent "Investor Intelligence" numbers (which measure such things) indicate the percentage difference between those who are optimistic about the future direction of the market, and those who are pessimistic, have reached the highest level since 1986. Only 13.5 percent of investors expect the market to decline.
This overly-optimistic view is a sobering statistic. The level of optimism is even greater than it was just before the 2008 crash. It has always indicated an extremely overbought condition in the stock market. For people like me, it provides a contrarian view that is invaluable in times like this. However, investor sentiment is not the only variable that we (or you) should watch.
Things like: how expensive are the markets versus earnings expectations? At the present level of interest rates, could valuations simply be considered fairly-valued? The Trumpsters could have it right. The markets may actually be undervalued if all turns out well on the tax cut front.
That is the reason why I have urged readers to stay invested throughout all of last year and into today. Sure, somewhere down the road (maybe even tomorrow) something will come along to knock the markets down anywhere from 3 percent to 10 percent. So what?
Don't try to time it. It is just too hard to predict what central banks will do next. What a non-politician in the White House will do or not do, or when this bull market will peak. If you have money to invest, start investing it a little at a time. You may be lucky in your timing and actually catch some of the long-awaited down draft, but don't get cute, or you may find yourself on the sidelines while the market gains another 10 percent.