Below is a snapshot of last week’s market performance and what to watch in the weeks ahead from Chadd Mason, Cabana CEO and co-founder.
Last week, in response to comments by Federal Reserve Chairman Jerome Powell, volatility returned to stock markets around the world. He stated on Wednesday that growth prospects had diminished globally and instead of reducing the number of interest rate increases this year, we would not have any. This promptly sent bond yields into a dive as equity markets tried to digest whether this “dovishness” was good for stock prices or if the Fed knew of problems down the road that no one else does.
On Thursday, markets seemed to settle the uncertainty, and stock prices climbed more than 1% based on the idea that easy money policies would continue to stimulate growth. No sooner than that began to sink in, Germany and U.S. manufacturing data come in on Friday morning, revealing recessionary conditions in Germany and much weaker (although still growth) conditions here at home. This gut punch caused investors to rethink the previous days optimistic interpretation of the Fed’s policy statement. Markets plunged, with risk assets taking the brunt of it. Small cap stocks and commodities dropped more than 3%. The major U.S. indexes all were down approximately 2%. From a technical perspective, these indexes dropped back below the resistance that we had just cleared ($280 on the SPY). Friday saw the biggest declines since early January and on big volume.
As we have discussed several times over the past weeks, markets have had an exceptional run up since the new year began and some choppiness is to be expected. What is not to be expected is the drop in bond yields at the longer end of the yield curve, which caused the yield curve to invert for the first time since 2007. This means that you are paid more to loan money for ninety days than you are to loan money for ten years! This is not normal and not good for banks, since they pay depositors at short-term rates and loan money to customers at long-term rates. Thus, banks lose money in these conditions. I am over simplifying here, but you get the point. An inverted yield curve has occurred before every recession in this country going back to 1975. With that said, while every recession has started with a yield curve inversion, not every yield curve inversion has led to a recession. There have been several occasions when longer-term interest rates rose in response to improving growth prospects and the yield curve returned to its normal shape. We will have to see which of these scenarios play out over the next few months.
There are a lot of positives out there in the form of historically low unemployment, a strong U.S. consumer and stable banks, which all support the idea that the bull market can continue to stagger forward. We are going to need some help from the rest the world, starting with a trade deal in China and a solution to the Brexit quagmire engulfing Europe. All this is possible, and I am hopeful, but the fact remains that we are likely in the 8th or 9th inning.