Did You Catch All This Last Month?

Well, vacation's over. Labor Day's past. We're in the home stretch of 2019.

With all that's happened this year, the month of August - last month - may have told us a lot about what to expect the rest of 2019 and beyond.

Rather than get caught up in the weeds, we'll keep it simple. We've talked about most of this in previous posts. But now the evidence has built up to the point where simple declaratory sentences work best. You'll have to simply believe that there's been a lot of reading, research, analysis, and thinking that have resulted in these declaratory sentences. Let's get started.

Bonds

The great bond bull market that began in the early 1980s has most definitely not ended. Great arguments were proferred before August that could have you believing it did or at least have you sitting on the fence. That's done. The yield on the 30-year treasury broke down, cleanly past the July 2016 low of 2.11. It ended August at 1.99. When it first broke below 2.11, we waited to see if it would simply bounce back up quickly. That happens sometimes when previous highs or lows are broken. When that happens, it creates what we call a "head fake." You think the trend has changed, but it hasn't.

This wasn't a head fake. The rates broke down and have remained there.

The much-watched 10-year treasury yield fell from 2.02 to 1.50 at the end of August. That's a fall of 52 basis points. In percentage terms, that's 49.5%. That's a HUGE drop.

The 2-year yield fell from 1.89% to 1.50% - a fall of 39 basis points or 20.63%. That's not HUGE, but it is BIG.

What about the dreaded inverted yield curve? 

It's inverted. Not by a lot. But it's safe to say that the waffling back and forth that had us wondering whether we really had an real inversion is over. While the month ended flat, the inversion had occurred on several days. Now with the beginning of September, it's inverted again. We can expect that spread to widen.

And, yes, it means a recession is coming. One of our brain trust members thinks the 2-year/10-year inversion is the most reliable of all indicators of an oncoming recession. But before you head for the hills, history tells us that we've got some time before things get bad. The last inversion was 2006, more than 12 months before the recession - and financial crisis - hit. Before that, an inversion occurred in 1998 - almost 2 years before the stock market began its historic 3-year plunge, accompanied by recession.

So what to think and do now? Our thoughts are we've got time, based on history, before a recession. And based on history, stocks will likely go up before hitting a wall. The time line: 6 to 18 months. The import of all this: The inception of an inverted yield curve, while a harbinger of recession, is not a signal to sell stocks now.

Stocks

As for stocks, they've remained in a trading range for months. All the volatility in August didn't change that. Some are saying we can expect bad days in the fall. And, indeed the fall has traditionally sometimes been a bad time for stocks. The 1929 Crash, the 1987 Crash, the 2008 Crash all happened in the fall. But offsetting this we have the timing of the inverted curve, previously described, which historically signals stock gains, as well as the Melt Up Theory, whose proponents remain stubbornly on point. Their argument: We haven't seen the crazed buying of stocks that mark the end of a bull market. And they're right about that. We haven't - at least as far as I can tell.

Now, that doesn't mean we won't get some big bad drops in the fall. Then again, we had these in December of 2019, and somewhat in August. Of concern, however, is the simple fact that stocks have not been able to make all-time highs. They keep falling short. Is this the sign of a dying bull, ready to keel over. Don't know.

For this reason, we're not making a declaratory sentence that says the stock bull market is not over.

But will the Fed screw all this up?

One rather startling comment in August by a former Fed member has us wondering whether the Fed might intervene in a big way and throw off all that we outlined above. Left to our own devices, we humans tend to follow certain behavioral patterns that allow us to look at the past and make some reasonable guesses about future trends. While that past won't repeat exactly, it does provide lessons, lessons based on human nature.

But the Fed is perhaps the most powerful organization in the world. If not overall (meaning more powerful than the U.S. federal goverment itself), then at least the most powerful financial organization. It can move markets and the economy like no other force. And in August, former NY Fed Governor Bill Dudley made it clear in public remarks that the Fed should do all it can to see to it that Trump is not elected.

While you may find this startling, understand that the Fed does play politics. It's just that you usually don't have someone come out and just say it like Dudley did. And he tries to convince us that this shouldn't be taken to be an outrageous comment. In his mind, Trump's pursuit of trade wars, especially with China, must be stopped. Either that or the economy will tank hurting all Americans. So he's saying the Fed must stop Trump to save us regular folks from disaster.

But just how would the Fed block a Trump re-election? Well, the only way I can fathom is by causing a stock market crash and/or recession before the election. As we all know, and as James Carvill famously said when asked what determined the result of presidential elections: It's the economy, stupid.

Does this make any sense to you? We're going to be "protected" from Trump by having the Fed create falling markets and economic recession? Now, Dudley didn't say the Fed should create recession. But I don't see how they'd undermine Trump without underming the economy.

August was indeed a meaningful month. There's more, but that's enough for now.

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