Everything looks very much different this morning, after the largest overnight point drop in the Dow Jones, ever. In the past 6 trading sessions, the US indices lost almost 10%, with an acceleration on black Monday contributing 4-4.5%. The VIX index got catapulted to a reading of 39, last seen during that market rout in September 2015. Treasury yields have corrected back down a little, in some sort of flight to safety, crude and other commodities were a bit weaker, but the FX market was fairly unfazed.
Now, the big question is whether this was a healthy correction, long overdue, or whether this was the starting shot to something much bigger, a few of the pundits also claiming long overdue. Only time will tell, but judging by the wall of money that has been chasing risk assets in January I would be surprised if we didn’t get a reprieve in short order based on bargain hunting. Further assessments will have to be made from there. For today, let’s have another look at rates.
Admittedly, long US Treasury yields had been spiking more than expected by this space, before the overnight stock move put a lid on them. It had become a sort of self-fulfilling prophecy, triggered by a combination of Bill Gross’ grandstanding, growth hypes, inflation yearning and chart dogmatism. The short-sellers were finally having their field day, and good on them. As the momentum goes, and discounting the stock market rout, the 10-year may still overshoot toward the 3% threshold.
In particular, Friday’s kick in yields was provided by the latest set of labour numbers, with non-farm payrolls coming in at better than expected +200k, and the increase in hourly earnings in particular. The January number was at +0.3%, and December’s got revised upwards to +0.4%, both readings being above the recent monthly average. This would be inflationary down the road, or so the logic goes, and that’s why yields at historically low levels would be unsustainable.
A couple of days earlier the investment community also got confirmation from the Fed that it felt that inflation would gradually rise. All stars have been aligned for the upward move in yields to happen. But maybe it is exactly such trembling before higher interest costs across the curve that stocks and high yield bonds have finally budged and are materially weaker now. As mentioned in a piece last week, Jerome Powell has his work cut out for him. If stocks keep falling, he won’t raise rates.
As ever, it’s best to exercise caution in light of such herd movement. As we know, the devil is in the detail. And while markets are always right, until they aren’t, a mean-reversion towards a more realistic yield picture is likely. Not to split hair, but the earnings report is misleading if one only looks at the hourly earnings. They may be up, but average weekly earnings are down from December to January. Guess what’s more important to employees and their spending pattern, and for inflation!
Also, according to the numbers non-farm labour productivity has surprisingly declined in Q4. It puts the so-called successes in the US labour market in perspective, as the increase in employment doesn’t get reflected in productivity. The real growth in employment has sadly been in sectors that neither add to earnings growth, as leisure and health care are typically low-wage jobs, nor to productivity, as the majority of those jobs do not make that much of a difference.
In other words, the economic recovery is less stable than the pundits think and/or propagate. Not that I want to be the party pooper here, and the market has taken over that job anyway, but let’s just be honest. Take the lagging weekly earnings, disappointing productivity growth and stumbling value creation in the manufacturing businesses, and the hype doesn’t seem to be so hype-worthy any longer.
Many readers may remember this space’s slogan of many years… 3% in 10 years may be the trade of the year, if you can get it… Well, what do you know? There may be a chance to get it shortly. And looking at the stock market it may well be the trade of the year. Don’t miss it.
