In “Alice’s Adventures in Wonderland”, Lewis Carroll declares: “For, you see, so many out-of-the-way things had happened lately, that Alice had begun to think that very few things indeed were really impossible.” (Chapter I, “Down the Rabbit-Hole”)
OVERVIEW AND CONCLUSIONS
History reveals that sustained rises in United State government interest rates generally (eventually) are bearish for the US stock marketplace. The United States Treasury 10 year note yield made a major bottom on 7/6/16 at 1.32 percent, an important interim low on 9/8/17 at 2.01pc, and a critical high in early October 2018 at 3.26pc. Japan’s 10 year government note yield peaked around then, on 10/4/18 at .17 percent. Germany’s 10 year government note rate established an interim high at .58pc on 10/10/18 (having built an earlier top at .81pc on 2/8/18). China’s 10 year central government note’s yield high occurred earlier (4.04pc on 11/22/17), but its lower yield high at 3.71pc on 9/21/18 connected with those in America, Japan, and Germany.
The S+P 500 attained its summit around the same time as the yield highs in the UST 10 year note, constructing a double top on 9/21/18 at 2941 and 10/3/08 at 2940.
Subsequent yield declines in the UST 10 year note and the 10 year government debt of other key global realms such as Germany, Japan, and China accompanied a slump in the S+P 500 and many other benchmark stock indices. The Federal Reserve, European Central Bank, and other central bank engineers initially were fairly complacent. However, around mid-December 2018, the rate for the UST 10 year decisively retreated beneath about 2.80 percent. Also around then, the S+P 500, after tumbling from 2800’s temporary high (12/3/18), cratered beneath 2650 (a ten percent fall from the autumn 2018 high). Note the subsequent change in direction for Fed policy orations and actions.
These fearful events (and other variables) portended weaker real GDP growth (and maybe even a recession) in America and other advanced nations, and an undesirable slowdown in China and other key emerging marketplaces. Stock owners (especially investors) and their investment banking and media allies in the United States and elsewhere screamed, troubled by the prospect of a twenty percent or more decline (satisfying a classic definition of a bear trend) in the S+P 500. Many politicians around the globe screeched, expressing concerns about economic dangers (more quietly, some worried about potential for increased populist pressures).
This unsettling scenario sparked the trusty Federal Reserve to halt its Federal Funds rate-raising policy (part of its normalization scheme), to underline that it would maintain a hefty balance sheet laden with debt securities, and to preach a much-welcomed sermon that for the near term it will be “patient”. The European Central Bank and other devoted central banking comrades promised continued easy money programs.
Some might wonder if the Fed and its friends in central banking (and in some political corridors) nowadays are aiming to produce an updated version of the joyous days (“irrational exuberance”, perhaps) of 2006-07 during the Goldilocks Era.
In any case, the central bank easing rhetoric and policy shift helped to rally equities and boosted confidence in growth prospects. The S+P 500 hit a floor on 12/26/18 at 2347 (20 percent fall from the autumn high equals 2353) and thereafter rose sharply. Many other global stock marketplaces established troughs around then, rallying dramatically in first quarter 2019. The UST 10 year yield touched 2.54 percent on 1/4/19. It thereafter climbed to 2.80pc on 1/18/19 (2.77pc high 3/14/19).
Given the reappearance of lower UST rates and the sunny prospect of continued benevolent Federal Reserve policy, arguably some of the feverish rally in the S+P 500 and other international stocks since around end December 2018/early January 2019 has reflected not only hopes of further (adequate) economic expansion, but also a frantic hunt for suitable returns (“yield”) outside of the interest rate securities field. The time of the broad S&P Goldman Sachs Commodity Index (“GSCI”)’s bottom neighbored that in the S+P 500, 12/26/18 at 366. Note also the price rally in US dollar-denominated emerging marketplace sovereign debt securities.
The broad real trade-weighted US dollar’s rally from its January 2018 bottom at 94.6 (Federal Reserve, H.10; goods only; monthly average, March 1973=100) established a high in December 2018 at 103.2 (recall the major top of 103.4 (December 2016)/103.2 (January 2017). The dollar’s stop in its bull charge and its slight decline thereafter (about 1.4 percent) probably has helped to inspire the stock marketplace rally and related quests for returns in other landscapes. The combination of the drop in US government yields and the cessation of the US dollar’s upward march probably (especially) encouraged the recent price climbs in the stocks and government notes of many emerging marketplaces.
For the S+P 500, the lower tax rates legislated via America’s end-2017 corporate tax “reform” spiked US corporate earnings and encouraged massive share buybacks. Although the tax reform will continue to support earnings to some extent, substantial year-on-year growth for (at least most of) 2019 earnings currently looks unlikely. Suppose marketplace enthusiasm generates a forceful challenge to the S+P 500’s autumn 2018 high occurs. The September/October 2018 elevation probably will not be broken by much, if at all. A one percent breach of 2941 gives 2970, a five percent advance over it equals 3088.
If further notable share buybacks and determined digging around for yields (“good returns”) are playing critical roles in the recent S+P 500 (and other stock) rallies, perhaps the S+P 500’s recent strength does not reflect the darkening vista for the American economy. US and other stock marketplace climbs from current levels do not preclude increasing economic feebleness in America and elsewhere.
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Economic Growth Fears- Stock and Interest Rate Adventures (4-2-19) (1)