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Market Lab Report - After the Open 8/27/18

With global interest rates still at or near record lows, it seems intuitively simple to assume rates will have to have a meaningful rise at some point. While this is likely to be true, timing is everything. Institutional investors making those bets such as bond legend Bill Gross have suffered markedly. His flagship bond fund has had close to 50% in redemptions due to his wrong-way bets on the bond market. Perhaps this is a reflection of how QE has more than muddied the waters, not just in the stock market but also in the bond market. QE capital flow remains at or near record levels, thus bond prices remain stubbornly elevated as QE finds its way into bonds and stocks. 

Gross rightly says that ultra loose monetary policies, which have artificially inflated asset values, have fostered a bubble of sorts. Former Fed Chair Alan Greenspan has echoed this sentiment, saying bond prices are too high so will have to drop at some point. This has been a concern to investors as the yield spread between short-term and long-term U.S. government debt, known as the yield curve, flashes yellow recession warnings as the yield curve has noticeably flattened. When spreads between short- and long-term rates narrow, it suggests that the market believes economic growth and inflation are not sustainable and will fall in the future. 

The spread between the 2-year note and the 10-year note is at its tightest since August 2007. An inversion of the curve — when long-term rates fall below short-term — traditionally indicates a looming recession. When the Federal Reserve raises interest rates, short-term bond yields rise much faster than long-term yields can react, flattening the curve. Further, if market participants think tighter credit conditions will bring an end to the economic expansion, long-term yields can remain stubbornly fixed. And more rate hikes loom on the horizon.

As it stands, traders are almost fully pricing in a rate hike at the Fed’s next policy meeting a month from now, and about 50-50 odds of a second increase by year-end, based on fed funds futures pricing. The spread between December 2018 and 2019 eurodollar contracts suggests traders expect an additional one-and-a-half rate hikes next year. The question remains whether the Fed will have room for this many more rate hikes before the bubble bursts, or a failing global economy prevents the Fed from taking such action. And should a serious global recession emerge, there is far less fuel in the interest rate gas tank this time around to jump start economies, such that Bridgewater's CEO Ray Dalio suggests a serious devaluation of fiat currency may be in the cards within the next couple of years. 

So while over the long run, the odds say Gross and other notables will be right, it remains a question of when their predictions pan out. Anotable economist John Maynard Keynes has said, “the market can remain irrational longer than you can remain solvent.” What may soften the blow is if Trump's pro-business, lower tax policies can somehow have a material effect on the economy sooner than later. The creation of manufacturing jobs have been robust. In addition, exponential growth technologies continue to evolve at breakneck speeds. 

Meanwhile, major US stock indices are achieving new highs. Many stocks, especially ones in China, have been clocked but are experiencing strong bounces today on news of a favorable trade agreement between the U.S. and Mexico which the idea that there may be favorable outcomes regarding trade issues with China. AMZN, SQ, and FTNT on our focus list remain shining leaders, though such names are few and far between these days. Other names such as PVTL to which we issued a pocket pivot report when it closed just above its 50-day moving average have also shown strength, but of course, taking gains when you have them in this market environment has been the prudent choice. Some of the former stalwarts such as NVDA are trying to show signs of life but in a terribly sloppy manner. As one can see, NVDA recently gapped lower on huge volume, then shot straight back up. While CANSLIMers may think this is a breakout, breakout patterns have not worked in years, so odds are that NVDA's sloppy pattern for all of 2018 may remain sloppy. 

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