Hold Steady as Fear Permeates (Again)


We are really on the roller coaster now. US stocks tanked last night — the biggest drop of the year. Aussie stocks will cop it today.

You’ve seen the headlines. Bad German data. The trade war.

But most of all — the yield curve.

What is it?

This is the shape of interest rates going from short-term to long-term ones. The key place to see this is the US government bond market.

The yield curve is said to be ‘inverted’ when the yield on the 10-year note falls below the two-year one.

Why would anyone care about such a thing?

Historically, these inversions happen before a recession…hence the stock selloff right now, at least in part.

Am I worried? No. I don’t buy this line of thinking. Today’s Profit Watch explains why…

Fears around the yield curve have been percolating for well over a year now.

Barely a day goes by without anyone mentioning it.

Nobody could be surprised to see this.

This possibility must have been priced in long ago…

Same, same — but different

I went back and checked an update from my Small Cap Alpha service. In December last year, I addressed the very same yield curve worry.

I suggested the market would climb this fear.

Hindsight now says the Aussie market had a roaring first half of 2019.

Why should the next six months be different?

Certainly, the market won’t completely collapse from something that’s been so closely scrutinised and floating around for so long. It’s just never that obvious or easy.

That’s the first thing.

The second is that it’s not clear whether the traditional signals behind the yield curve are as clear-cut as they once were.

For example, an inverted yield curve was traditionally problematic for banks because they borrow short to lend long.

Banks in trouble are problematic for the economy at any time.

That’s not the case right now.

My former colleague, Chris Mayer, just pointed out that the net interest margin American banks earn rose against falling rates from 2015-2018. US banks look to be in good health.

I also pointed out last year that Warren Buffett keeps loading up on US bank stocks, too. We can presume he’s at least done his homework on this.

Note that mortgage applications are rising in the US…thanks to low interest rates.

There is also many other dynamics at work.

Most government bond yields around the world trade at negative interest rates. The US is one of the few markets with positive yield.

Falling long-term rates may no longer signal investor expectations in the same way they once did.

It may be that US government bonds are simply being bought for the income…and the market is misinterpreting the reason.

There’s another interesting point that I saw this morning…

US government ‘pump priming’ is running riot

A research note that landed in my inbox says that every recession in the US in the last 50 years has been preceded by a tightening of fiscal policy.

This refers to US government spending.

Here’s one thing we know right now. Trump’s government is running up record deficits. Fiscal policy is loose!

It was only two days ago that The Wall Street Journal reported that the US federal deficit was 27% higher than the same period last year.

Think about this for a moment. President Trump has no qualms about bashing the Fed (the US central bank) via his Twitter account.

And yet nobody is calling out the President for his lavish spending…at a time when one could well argue that he’s exhausting America’s reserve firepower if trouble really hits the US economy.

Please remember that US GDP, employment and wages are all ticking over just fine right now. It’s not 2009 over there.

Worry about Trump, not the yield curve

The low rates in the bond market are giving Trump a free pass to run massive deficits, and pump prime the markets and the economy. This is unlikely to hurt his 2020 election chances now, is it?

One could very well argue that it’s the US government deficit we should be worried about.

I still remember all the angst back around 2012 when many investors viewed US debt and the dollar as unsustainable.

Now nobody seems to mind. That could turn again at some point.

Let’s get one other thing clear as well. Stocks are volatile. They go up and down. One bad session does not necessarily ‘mean’ anything.

We’ve come full circle since last week. Turn these selloffs to your advantage.

Look to acquire stocks you want to own at lower prices. Watch for stocks that sell off the least to gauge their relative strength.

Just remember you’ll never pick the exact high and low in the market.

Best wishes,

Callum Newman Signature

Callum Newman,
Editor, Profit Watch