Market update 12.6.18
-Darren Leavitt, CFA
Good afternoon, we wanted to put out a quick note to address the market volatility that we have witnessed over the last couple of sessions. There are a number of different factors that have influenced the recent action.
First, I think the inversion of the 2-5 year note spread caused a bit of a panic on Monday. The influential Financial sector, which counts on an upward sloping yield curve to create their net interest margin, has taken a beating with the recent move in yields. Many investors seem fearful of an inverted yield curve as it has generally been associated with an impending recession. However, the 2-5 spread has already been inverted a number of times within this bull market. Additionally, I have recently read a great note from a good friend and former colleague, Brian Reynolds, that points to the Agency curve which is still relatively steep- this curve has been arguably much more important in this credit cycle than in the past with more money being invested in issues such as Freddie Mac and Fannie Mae bonds for the increase in yield that they offer and the almost 100% guarantee of the US government. Banks, Pensions, and Institutional investors have been increasingly active in these markets for the last couple of years, and this could suggest that this is the curve that we should be watching. That said, there is no doubt, that a yield curve inversion affects investor sentiment and has played a part in this week’s volatility. But inversions in the past have not necessarily meant that the market was in trouble, in fact, the equity and credit market generally rally for an average of 18 months to 24 months after the 2-10 curve inverts. It is yet to be seen if economic growth is slowing materially. Interestingly, today we had the ISM Non-manufacturing number come in at 60.7%, better than the consensus estimate. This reading suggests that the services sector still appears to be healthy and on solid footing. However, the recent dovish tone from the Fed is perhaps suggesting something different. Just like the upward moves in the market last week, today’s market’s rally off the lows was in part helped by a WSJ article that suggested the Fed “would be more cautious-minded about raising interest rates following the December meeting.”
Second, world trade is a huge uncertainty. While we heard constructive tones out of the G-20 last weekend that rhetoric has come under some scrutiny, I saw one poll after the G-20 that suggested a 40% probability that China and the US would come to an agreement and in the last couple of days seen the poll down to 30%- these are not the kind of probabilities the market wants to see. Additionally, there is the potential for new conflict between the US and China after the arrest of the CFO of Huawei. This was certainly in focus this morning and could further hinder US/ China trade relations. Brexit has also come to the front of the line for investor concern. The headline that Theresa May is being held in contempt by Parliament was cited as a possible catalyst for Monday’s sell-off. Again, this uncertainty has given investors reason to pause.
Lastly, technically the market is in a critical area. Today it was helped with support around 2650 area. However, in the near future investors will be pointing to the potential of the ominous death cross, where the 200 day moving average moves through the 50-day moving average. On the other hand, many issues appear to be quite oversold, and this really seemed to play a prominent role within the Tech sector’s outperformance today. Despite the broader market being fairly close to last month’s lows, many leadership names were able to stay well off their lows- I would view this as constructive.
There is undoubtedly a lot to consider right now, and as always we are here to answer any of your questions. Are models remain quite defensive and have been helped recently by our overweighting in 7-10 year duration bonds and underweighting in equities.
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