It’s a fascinating time to be an investor. It’s also challenging. There are so many things going on around the world that can really confuse the Market landscape. I am unaware of any other time in my life where I’ve asked the question in my head so often: “Did that really just happen?” Global norms have been tested and trampled, some for the better, some not so much. The Digital Age has connected the world like never before. Connections can be loose and they can be tight. Sometimes it feels like a tug-of-war. A constant throughout this Bull Market has been: when earnings are the focus, stocks perform well. When politics and geopolitics attract attention, volatile price action results. Studying the major crosscurrents below the surface reflects some of the turmoil above.
The good news: Earnings are strong. The bad news: It was expected and have largely been priced in. The key: The Outlook for the rest of the year. So far it’s been mixed. It’s still very early. Only 10% of S&P 500 companies have reported. Next week will be a doozie with Amazon, Google and Intel among others. It will no doubt be Market moving.
An important factor: Commodities continue their strength. Demand for the stuff that drives economic activity like Copper, Aluminum, Steel and Oil keeps growing. West Texas crude is back near $70, a level not seen since 2014. Brent crude cleared $74 for the first time in 4 years. The price of oil has been booming. Oil knows boom and bust. Aluminum prices have surged of late too, reaching all-time highs. Iron was up 5% this week alone. All this after the tariffs. President Trump tweeted about artificially high oil prices and OPEC manipulation. There’s only so much OPEC can do. Investment in energy production outside the US has been lacking and demand has been surging. The tweet took Oil prices down initially, but they reversed course to close out a strong week at those multi-year highs. These are good signs for a strong global economy. But considering activities with OPEC to reduce production in order to increase prices, Venezuela’s crisis which has seen production plummet and the potential sanctions on Iran and Russia, the price of Oil could very well go even higher. That could ultimately be a bad thing. Despite major advances in renewable energy, the world still runs on crude.
Interest Rates, the Yield Curve & the Credit Market
Interest rates are on the rise. But not everywhere. The yield curve has been flattening. That’s rarely a good sign, but it can be explained. Interest rates are rising on the front end of the curve as the Fed has continued its rate hike campaign. But rates have been stuck in place on the back-end of the curve, and actually fell the last few weeks, which has made the curve flatter. The spread between the 2-year yield and the 10-year yield on Treasuries shrunk to 41 basis points (0.41%) this week, the tightest since just before the Financial Crisis. The curve from 10 to 30 years is now just 20 basis points (0.2%), also the narrowest spread since 2007. Central Banks have kept rates artificially low for years in response to the Financial Crisis, and it still has great influence. There have been some unintended consequences. That means that a Bond buyer would only get 0.2% increase in interest payments for taking an additional 20 years of risk to buy a 30-year Treasury bond. That is not an attractive prospect.
The tightening of the yield curve is raising some concerns, as the event has often indicated a weakening longer-term outlook for economic growth and inflation. The Fed is paying attention, as are we. An inverted curve has been a signal of looming recessions that historically has occurred when the Fed is in a tightening cycle, and the Market loses confidence in the economic outlook. It’s not the case now. The Credit Market, which is the circulatory system for Corporate America, is showing no signs of stress. It flinched a little in February with the immediate shock from the correction. But it’s regained its health. The Credit Market will be the ultimate tell for us that serious problems are ahead. But the Market is forward looking. The way we see it, earnings growth will likely peak this year, with the rate of growth slowing next year. 2020 is a total wildcard, but we expect economic activity will slow further and the Market will sniff that out in advance.
The S&P is now breakeven on the year. It was up 5% to start January. It fell 10% in February. It’s now back where it started. It’s like nothing has happened in 2018, right? Wrong. So wrong. So much has happened. We suspect there’s plenty more to come. We’re all over it.
Have a nice weekend. We’ll be back, dark and early on Monday.