More August Face-Plants. This Time with an Inverted Yield Curve

Whew! This August is starting to smell a lot like last December, if you know what I mean. The market is trying to commit hari-kari. But some of us are wondering why.

The latest reason for markets to reach for a suicide weapon is the dreaded “inverted yield curve.”

Let me try to explain the term for those who have been following news of this Martian landing since yesterday morning.

The yield curve is a simply depiction of interest rates from current to longer dated. The curve normally has an upward slope to it. Makes sense, since the risk of not getting your money back is larger the longer it is out of your hands. Think about a CD.  Should you get more interest for a one-year CD or for a five-year CD? A five-year, for sure.

Yesterday morning, the two-year US Treasury Note, for about two hours, paid more interest than the ten-year Treasury Bond.  History shows when this happens – and it happens infrequently – it is a harbinger of a recession a year of two in the future. And, for sure, recessions kill stock markets.  So we don’t want recessions, and we don’t want inversions of the yield curve.

But every inversion does not, and has not, given rise to a recession.  But investors still worry at the first sign of a yield curve inversion.

So, should we be worried?  Short answer from me: No.

Here’s why. Typical inversions occur with a number of things going on.  Current interest rates are rising because the Federal Reserve is RAISING interest rates to slow down a hot economy, and long-term rates are falling because investors see that the rising short-term rates are going to hurt the economy.

That’s not what’s going on today.  Today, current rates are very low and probably going lower. But ten-years bonds are about as low, if not lower, because an incredible $15 trillion of government bonds throughout the developed world are paying NEGATIVE interest rates. (Negative interest rates were unheard of until a few years ago.) Negative rates pay back people LESS money than they invested originally.

Why would anyone do this?  Because investors around the world are terrified of financial conditions in many places, and developed governments in Western Europe thought this would be a good way to force people with money to take risks or banks to lend more money. Because if you didn’t put your money in a non-interest bearing investment, then you will be punished with a negative return on your money.

Has it worked?  Not a bit.  But that doesn’t mean governments will admit defeat.  Heck no! They will try negative rates any day rather than lower taxes and reduce anti-business regulations to stimulate real economic activity.

The upshot of this mess is that massive amounts of foreign and domestic money is moving into the US government bond market. And, please know, when there is more demand for bonds (or anything else), their price rises and their interest paid falls. Hence, our ten-year Treasury bond is being driven towards the lowest rates in US history.

These are not preconditions for a recession, except for the fear that surrounds our markets.  Otherwise, America’s economy looks good – not great – but good. With low interest rates, low gas prices, plenty of jobs, and an economy that is 70% consumer-driven. It’s the hottest – maybe the warmest – economy in the world.

August will pass. Short of something more substantive than foreign money driving down our interest rates we’ll get through this.  Once again, we look at the power and the corruption of a press/media complex that is more attuned to creating fear and viewership than explaining what is really going on.

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More Face-Plants

I opened the month with a comment on the market doing a face-plant.

The market continues its face-plants.

Long-term indicators are now even more positive while short-term indicators, highly volatile of late, remain slightly negative. The biggest positive I see are the new lows in corporate bond yields. It can hardly be overstated how positive it is that corporate bonds have made new lows. If our economy were on the cusp of a recession, corporate bonds would be getting much riskier, and their yield would rise to reflect that heightened risk. This would not be the time for them to make new lows.

Over the last 100-years, there have only been three times when corporate bond yields gave false positives (remaining low as a recession approached) on the economy, one of which was the 1945, the end-of-WW2, and the coming of demobilization, and another was the deep recession in 1938 as a result of fiscal tightening. Today, we are not suffering from a fiscal tightening.

Also, the lack of inflation gives the Fed wide latitude to cut rates further, if need be.

Another reason for me to believe things are not as awful as the markets seem to believe is the money supply. It is still rebounding from a two year decline, but its improvement is another sign of stable growth in both borrowing and bank lending. The consumer is still strong.

Yet, there is real terror out there.  Blood in the streets kind of terror. Interest rates have fallen so fast and so far.  Foreign growth is virtually non-existent. Trade issues are concerning people and freezing American businesses from making investment decisions.

Take a look at the chart below. It’s from American Association of Individual Investors.  These aren’t professional investors. And they are as scared as they were last December and almost as scared as they were in the depths of the Great Recession of 2008-09. What you see in the chart is the spread between those non-professional investors willing to buy and those who want to sell. The chart shows that, in spite of the S&P 500 being near an all-time high, small investors are at -26.5, meaning many more are looking to sell than buy.

Ironically, this degree of negativity is much more often a sign of a coming strong move up than a move down. Check the chart to see what I mean. The green line rockets up – or it has in the past – when the reading gets this negative.

For sure, I don’t know what’s ahead; but if you’re not out of the market yet, I’d suggest you hang on.

Blessings to you all.

Posted in economic recovery, fear, investment myths, investment wisdom, market corrections, Market falls, market volatility, Personal Finance, retirement investing, Successful living, The Great Recession | Comments Off on More Face-Plants

August opens with a face plant

The market has started August on on a disappointing note. It fell over 3% this past week; it’s worst week since January.

August tends to be a rough month, and following recent new highs in the stock market, the poor start is not a surprise. Immediate “causes” cited for the fall were disappointment in the framing of the FED chairman’s remarks accompanying the quarter point drop in the federal funds rate. Many argue the drop was unnecessary and gives up ammo that will be needed in the next recession. But other investors had a tantrum that Chairman Powell did not signal that this drop of a quarter percent is not the first of several.

The market’s fall was exacerbated on Thursday afternoon when Pres. Trump tweeted his decision to put more tariffs on Chinese imports come Sept 1st.  Count me an agnostic on the bad effects of tariffs on an economy the size of ours. China is hurting economically and so is much of the world, but the American economy still appears reasonably strong.

Then, too, seasonal effects play into August (and even September) being challenging months for the market.

How far the market will fall is unknown, but the US economy is still the engine driving the global economy. The US market also contains most of the world’s most profitable companies.  In a low-return global environment, it is hard to see how the US market will become unattractive to global investors.

In addition, our relatively higher interest rates are drawing much global capital, since many developed nations are sporting negative interest rates in a weak attempt to stimulate their own national growth. For these foreign lands, setting rates below zero will not, I believe, engender  growth and investment. Only policies that incentivize growth – like lower taxes, less regulation, and ceasing the demonization of success – will do that.

Blessings to you all

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Feels a lot like watching snow melt

The market has been doing nothing.  Nothing for a year-and-a-half.

I enclose a screenshot, below, I took this morning with equity futures down a little bit. If you carefully study the chart below, you will see the right-end of the chart line – that’s the S&P 500 yesterday.  On the left, faintly seen under the little range chart, is where that same line was at the beginning of last year: it’s just about as high as it was yesterday. In the middle, you see the market lurching upward and downward, putting in a new high for a day or so, and then falling.  Sometimes, sharply, like last December and sort-a like last month, too.

There’s a Dionne Warwick  song I recall from the late 1960s, very popular, “What’s it all about Alfie?”

I could say the same about this market. Sometimes, and sometimes for long times, the market just sits. It goes nowhere. It’s dangerous to give up on it, but it tempts you to.

I caution you, dear friends: no one ever gets the market right all the time or for long.  Like a great baseball player hitting 300, that player will wind up in the Hall of Fame. But investors have to do better than 300 – not bat a thousand – but just better.

While 2017 was a gangbuster year for the market, following Trump’s election in 2016 – and gains needed to be consolidated – 2018 and 2019 have been mired in puzzles within riddles that, for now, don’t have an answers: China, tariffs, possible trade wars, immigration, Mueller, Putin, No. Korea, Iran, socialism. Even while employment is good, regulation is less harmful, economic growth has improved, and more, there’s a lot for markets and investors to digest. Plus, Trump does not make it easy and the next Presidential election is just over the horizon.  Markets worry what will happen: will America throw all the economic improvements away to explore the wonders of socialism?

Corporate earnings have plateaued for now. It will take more to keep them rising.  They fell a bit last quarter, and they are likely to do so again this quarter. By year-end, and for the whole year, they should, however, rise 5-7%, about normal for corporate earnings in a healthy economy. The nation’s economy surprised many by growing over 3% in the first quarter.  It won’t do that in the second, in my opinion; probably growing at only 2%. But the first quarter may soon get revised up a little bit.

But it’s very hard for investors to hang on. It takes discipline and faith.  Emotions are an investor’s worst enemy. I am surprised to no end, looking at fund flows, as I do, seeing what I see.  These flows track investor movements into and out of stocks and bonds. To my continuing amazement, far, far more money is going into bonds these days, and far more is coming out of stocks.  Gold is also at a multiyear high right now. Fear reigns.  Frankly, most of the time it does. But in much of the developed world, people are piling into bonds when yields are negative; that is, a ten-year, say, German bond is paying NEGATIVE .3% per year.  Understand, my friends, that means that an investor in those things get LESS than their original investment when they pay out ten years hence. This is what fear looks like – to me, a lot like stupidity. And, right now, Portuguese ten-year bonds are seen as less risky (What?!) than American bonds.  But American ten-year Treasury bonds are only paying about 2% a year.

I hardly think 2% is adequate compensation for parting with my money for a decade.  These are crazy times we live in, when a sizable portion of Americans, especially under 40, say we’d be better off trying socialism.

For me, I’m going to stay the course with my broadly-diversified, equity-oriented, low-cost mutual fund and ETF portfolio. I’d recommend you do the same, though I don’t know the future for sure. Nor I don’t see a recession in the next twelve months. However, if one hits, socialism is more likely in our future.

Keep the faith and blessings to you all.

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Market Hissy-Fits, Tariffs, and Chinese Trade

I am fascinated by business and the investment world. Those of you who know me personally know that. But two attributes of the investment world that are tiresome and troubling to me and many others are its excessive short-term focus and its selfishness.  It’s a “what’s in it for me attitude?” along with a “what’s in it for me today?” angle. Or, maybe even “this morning!” In the long run, the market gets things right; but in the short run, we have to put up with a spoiled child’s regular propensity to throw hissy-fits.

The tariff issues with China are a great case in point. China has had higher tariffs on US goods for years, stolen our technology, and made US companies agree to onerous terms to play in their markets. Average tariffs on Chinese goods, until recently, coming into our country were about 3%; ours going into China, about 10%.  Recently, the 10% has dropped to 7.5%. We’re making progress, in other words even without a final agreement.

But the stock market seems breathless over this matter. Yes, our consumers are paying more for a raft of goods coming into America, and our farmers are hurting over China’s retreat from buying our agriculture. We’re looking at a few hundred billion dollar problem set over against a $20 trillion national economy. At one point, it made perfect sense to look passed China’s trade abuses. After all, China was a new international economy, exiting, we thought the worse of communism, and going to change into a more democratic, open nation, as it succeeded. Now, it’s the second largest economy in the world. It’s still a communist nation, rough on its people and those with whom it trades. It’s time it grows up  in international trade and stop the bullying others trying to do business with it.

This has been a rough up and down market this month, supposedly, among other things, because of China and tariffs and a looming trade war.

“What if this goes on and on?”  “Who’s likely to win?” I believe the odds are in favor of the U.S. winning, especially since a trade deal with China to satisfy Trump is likely to end up being a win-win for both nations and their economies.

Clearly, the best trade policy is free trade, with no tariffs, barriers to entry, or subsidies. Free markets and global trade have proven to be the best way to promote global prosperity for nations and their people. Tariffs are best viewed as a tax on imports, with the cost being paid by the consumer, not by the producer. Taxes, or tariffs, serve only to reduce private consumption in order to fund government consumption, which in the end is less efficient. The country that taxes its imports least is, therefore, the country that will benefit most from trade. By the same logic, countries that subsidize their exports only hurt themselves while benefiting those who buy their subsidized goods and services.

Most economists would also agree that there are “second-order effects” that stem from tariffs. By making imported goods more expensive, countries that impose tariffs on imported goods give domestic producers a degree of “protection” to the extent domestic producers can charge higher prices and still compete with imports. But this only reinforces the argument that at least part of the cost of tariffs is born by consumers. Protectionists also argue that tariffs save jobs—and to some extent they do, in the “protected” industries—but only at the expense of consumers and international competitiveness. Tariffs, in short, benefit a relative few at the expense of the many.

Even though many feel Trump is an idiot and a liar, he understands all this – trust me – and said so, last year, at the G7 summit meeting: “That’s the way it should be, no tariffs, no barriers … and no subsidies. … that would be the ultimate thing.” His fellow national leaders at the G7 were not listening. The only way to understand Trump’s apparent love for tariffs today is that they are, as Larry Kudlow, his Director of the National Economic Council, noted a few months ago, “a negotiating tool. They are part of his quiver.” Nothing more, nothing less. And tariffs are a policy tool over which Trump has direct control. That makes tariffs irresistible to deal-maker Trump.

A war of escalating tariffs between the US and China would be damaging to both countries. If carried to an extreme, a tariff war with China would most likely endanger the global economy by weakening both the huge U.S. and Chinese economies. Bad stuff, indeed! And in that sense Trump is crazy to be engaging in a tariff war with China. Worse, he falsely argues that his tariffs are paid by the Chinese and that the money goes straight to the federal government’s coffers. To his credit, Trump’s economic advisor Larry Kudlow correctly admits that tariffs are in fact paid by U.S. consumers, not the Chinese. But he also correctly adds that higher U.S. tariffs will hurt the Chinese as well (because their exports will become more expensive when they arrive in the US, causing Americans to consider other product offerings). So the question then becomes, “Who will suffer the most?” “Who will likely back off from this game of chicken the first?”

Many believe, and I’m among them, that China is in the more fragile economic position in this cat fight, even though it is clear that Trump’s higher tariffs on Chinese imports impose burdens on U.S. producers and consumers.

Next time you hear that the costs of the trade war are simply being borne by Americans, be suspicious. In their zeal to make Trump look stupid or completely wrong on tariffs or other issues, too many commentators pick and choose their arguments. A more fair and complete economic analysis indicates that China is also a big loser in this trade skirmish. Trump’s threats are exerting real pressure on China.

Markets, in spite of their repeated hissy-fits in the short term, are usually efficient at discounting the future, if only because they reflect the consensus of millions of participants with skin in the game. Right now, those millions of economic actors, investors, and thinkers are saying that although both the U.S. and Chinese economies are hurting, the Chinese are hurting more.

Blessings to you all.

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