Tandem Advisors: Financial Markets Review
“Now that people are dismissing the notion of a business cycle, the ability for a country to enter a recession and speculators all but betting the house that volatility will not rise in the near future, we might look back and conclude the “wall of worry” was officially breached in April 2019.” – Observations, 5/3/2019
Last month, we touched on how the most recent direction in stock prices has a way of setting market narrative. There was chatter that the business cycle was now a thing of the past and the odds of a Western country ever entering a recession going forward were remote, at best. As the S&P 500 steadily rose through April, it became increasingly evident that complacency was back and many of the concerns that arose over the preceding six months were no longer concerns. And with that, on April 30th the S&P 500 closed out the month at an all-time high.
As we entered the first few days of May, it was evident the script had flipped. The perceived belief that the U.S/China trade spat was concluding was quickly squashed when President Trump issued a deadline to increase the 10% tariffs to 25% on an additional $200 billion worth of goods. And just for good measure, he didn’t want to leave Mexico out of the tariff party, so President Trump slapped a 5% tariff on them with specific dates as to when those tariffs would increase. By no means am I an expert on foreign economic policy and I don’t pretend to be one. The threat and implementation of tariffs might ultimately be a great tactic for long-term change; however, I can promise you there will be short-term pain.
If markets continue to rapidly deteriorate over the next couple of weeks, I think a 25-basis point rate cut would almost be a certainty.
The pain was certainly felt within U.S. equity markets in May. The S&P 500 declined for the fourth straight week to end the month lower by 6.58%. This was the first monthly decline of the year and the worst May since 2010. Along with declines in the S&P 500, the Nasdaq, Russell 2000 and DJIA also posted losses of 7.93%, 6.64% and 6.69%, respectively. Meanwhile, U.S. Treasury yields continued their march lower and seemingly flew off a cliff in the last two weeks of the month. Over the past four weeks, the 10-year and 30-year Treasury bond fell 37 basis points, while the 5-year Treasury note fell 36 basis points. The 10-year Treasury – the most talked about maturity – yields 2.13%, which is now down 112 basis points over the past six months. That is an absolute stunning move! As the longer end of the Treasury market fell, the shorter end also declined, but not by nearly as much. The 3-month T-bill and 6-month T-bill declined 7 and 10 basis points, respectively. What this boils down to is that the Treasury curve has just inverted by an even greater amount than it already was, which has historically not been a good omen for the U.S. economy. In fact, 1-month T-bills are now inverted out past 10-year Treasury bonds, as the 1-month T-bill yields 2.34% compared to a 2.13% 10-year Treasury.
The recent sharp decline in equity markets, government bond yields and commodities are all signs of slowing growth ahead. And, one thing I’m pretty sure of is the Federal Reserve will be there cutting rates in the very near future. Currently, the market is pricing in a 15% chance of a rate cut at the June meeting, 47% chance at the July meeting and a 75% chance at the September meeting. The 15% chance in the meeting 3 weeks from now actually seems a little low to me. Considering the Fed Funds rate is now higher than all U.S. Treasury maturities, except for the 30-year, which is only 7 basis points higher, I think it’s almost a given that the Fed will cut rates in a few weeks. In my mind, it is only a question of how much they will cut. If markets continue to rapidly deteriorate over the next couple of weeks, I think a 25-basis point rate cut would almost be a certainty. And, it would not shock me in the least to see a 50-basis point cut. The question at that point would be how the markets respond to such a move. Over the short-term, I think it would undoubtedly be positive for U.S. stock prices, as we’ve been groomed to celebrate central bank intervention. In the longer-term, it will be interesting to see if the Fed really has the power to suspend the business cycle, which was being predicted no more than six weeks ago.Observations 6.1.19