COOLER HEADS ARE PREVAILING

Stocks opened sharply higher today, recovering from last week’s dip. The Dow is currently up 265 pts and the SPX is up .9%. All eleven major market sectors are the in green, led by energy (+1.7%) and tech (+1.3%). European stock markets are poised to close roughly .5% higher, and most of Asia was up overnight. Commodities are moving with stocks. WTI crude oil climbed back to $60/barrel. Most of today’s stock rally is owed to the fact that bonds are finally selling off. Investors have fretted about the fact that Treasury bond yields have fallen back to 14-month lows, suggesting that perhaps the bull market has come to an end. In fact, today CNBC’s Bob Pisani said that the dividing line among investors is whether or not one believes an economic recession is imminent in 2020.

Of course, it’s not just lower bond yields that present a problem. It’s also that longer-term yields have been falling faster than shorter-term yields. The difference between the 10-year Treasury yield and the 3-month Treasury yield -1 basis point. That is, the 3-month pays more interest than the 10-year. This, of course, is not normal; the yield curve is usually upwardly sloping, not inverted. Investors are wary of inversions in the yield curve because such conditions can be a sign of coming economic recession. However, Goldman Sachs published a research report today saying that a good part of the inversion can be explained by overseas investors who see US bonds as a much better investment than their own sovereign bonds. This is true. The current 10-year German Bund is paying -11 basis points—that is, you are guaranteed to lose money. The current Japanese 10-year sovereign bond is paying 2 basis points. So in relative terms, the 10-year Treasury yield of 2.43% looks pretty good. Goldman points out that if the bond market were truly signaling coming recession, credit spreads would be widening out. That is, investors would be selling off junk and near-junk bonds. But we just aren’t seeing that. Credit spreads are narrowing.

Jim Paulsen of Leuthold Group agrees the yield curve inversion is “spooky,” but says it doesn’t mean recession. It will get resolved “either with stronger data coming out on the economy, or the Fed will have to cut” short-term rates. “I would stay bullish because I think the odds of recession are still more remote than likely.” Absent recession, there is “quite a bit” of upside for the stock market.

Of course, traders and reporters are poised to panic at the first sign of weakness in stocks. After a massive recovery rally this year, the stock market is losing momentum. We should, if history is any guide, expect a normal period of consolidation. But as I have said, the financial news media is quick to attribute this loss of momentum to recession fears. Ritholtz Wealth Management CEO Josh Brown acknowledges weakening economic data overseas as well as a flat US yield curve, but said these factors will not drag down the US. He rejected the “panic on the airwaves on Friday,” saying, “We go through this every single year. It’s called residual seasonality. The first quarter is always a disappointment,” whether due to a port strike, weather events or government shutdown. “You will see a bounce-back in the data as we get into Q2.” Mr. Brown highlighted the positives investors should focus on. “The consumer is on fire, the small business owner is on fire. Financial conditions have not been easier in 13 years. Money is flowing, businesses are growing, hiring, wages are going up.”


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