June 1, 2016

Stocks gapped down at the open but quickly recovered (Dow -21 points; SPX flat). The Nasdaq is up slightly. Telecoms are down 1% in early trading, along with gold miners, banks, and transports. On the other hand, biotechs and semiconductors are higher. WTI crude oil is trading down just under $49/barrel. Gold and copper are down modestly as well. Bonds are trading nearly unchanged again. The 5-year and 10-year Treasury yields are hovering around 1.38% and 1.84%, respectively. By the way, the average 30-year fixed mortgage rate is around 3.65%, according to bankrate.com. 

We’ve heard quite a bit lately about the fact that the bond “yield curve” is flattening. That is, short-term interest rates are going up in anticipation of Fed rate hikes, whereas longer-term rates aren’t moving up because inflation and economic growth expectations remain very low. Typically, yield curve flattening and even inversion are seen before the onset of recessions. But in last weekend’s edition, Barron’s asserted that the yield curve is clearly still in its “normal range.” And in fact, before the last four recessions the yield curve was completely flat or inverted each time. Currently, the 10-year Treasury yield is about 1.50% higher than the 3-month Treasury Bill. That’s not a large difference, but it’s also not necessarily a warning sign. 

With rates so low, CNBC asked fixed income analyst David Ader what value is left in Treasuries. First, he said, there is some value to foreign investors, who see Treasuries as having relatively attractive rates compared with their own local bonds. Second, Mr. Ader lamented the fact that the Fed has meddled in rates to keep them artificially low. Third, he said productivity is slowing down—that’s a grave accusation—and the world is ageing. This is an ultra-long-term trend keeping rates lower than they were in the past. Finally, the shape of the yield curve suggests the bond market isn’t concerned about improving growth or rising inflation. And as long as growth & inflation expectations are low, rates will remain low. He doesn’t think the 10-year Treasury yield will eclipse 3% for another several years. 

The ISM Manufacturing Index rebounded a bit in May, rising to 51.3 from 50.8 in the prior month. Remember, any reading above 50.0 indicates expanding business activity. The forward-looking “new orders” component of the report held steady at 55.7, which is healthy. This report is likely to be greeted warmly by investors because it demonstrates unexpected improvement in the manufacturing sector, which has been really weak for quite a while. Finally, we’re seeing the positive impact of higher oil prices and a weaker dollar in 2016. 

From time to time I mention Citigroup’s US Economic Surprise Index, a helpful tool that gauges whether or not economic data are coming in better or worse than expected. Over the last 3 weeks the index has improved from -38 to -19. Yes, those are still negative numbers, meaning the economy remains tepid. But it is improving. Meanwhile, investor sentiment is absolutely terrible. The Assn. of Individual Investors (AAII) Bullish Sentiment Index has sunk to 17.7. That means only 17.7% of surveyed retail investors have a bullish view of the stock market. So the index is right back even with where it was in mid-January when stocks were falling. History tells us that when retail sentiment gets bad, institutional investors start buying. We’ll see if that plays out this time. 

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