Stone's Weekly Market Guide - Week of July 22, 2018
Chart of the Week: What does the yield curve mean for the U.S. economy and stocks? A previous Chart of the Week dealt with the 10-2 inversion (2-year Treasury yield higher than the 10-year), but the Fed recently published research suggesting that looking at the 3 month 6 quarters forward less the 3 month rate was superior in forecasting recession. The 10-year yield is at risk of being impacted by factors not helpful for predicting recession. The good news is that this new spread is going in the opposite direction of 10-2 and indicating that the U.S. recession probability is low. In addition, our research shows that stocks have not usually peaked until after this new measure inverts.
For those interested in seeing the flattening of the 10-2 curve, please see below. It actually hit the flattest level since the Great Recession at one point last week and could make you nervous that a recession is close given its track record of prediction.
Now the Fed's preferred measure (3 month 6 quarters forward - 3 month yield) is giving a different signal. I do agree that other factors (rather than just recession indicators) are weighing on the 10-2. Low long-term inflation expectations, central bank purchases and very low 10-year yields in Europe and Japan are just a few items. I also looked at 10-2's predictive ability across countries with ultra-low long-term rates (Japan) and it does not perform as well as in the U.S. I'll be monitoring this new measure closely going forward.
Trade news is expected: EC President Juncker meets with President Trump on Wednesday regarding auto tariffs; the World Trade Organization holds a General Council meeting starting Thursday regarding the trade conflict between the U.S. and China; and NAFTA renegotiation talks between the U.S., Canada and Mexico restart on Thursday. While the tariffs are currently only a small economic headwind relative to the large stimulus from the tax cuts and increased government spending, markets will be monitoring whether the global trade conflicts continue to escalate.
July manufacturing PMI data provide a read on the major economies: U.S. expected to slow to 55.1 from 55.4; Eurozone should moderate to 54.7 from 54.9; and Japan was at 53.0 in June. All should remain well above any levels of recession risk, but the possible degree of loss in momentum will be watched closely.
U.S. June housing data are on tap with existing and new home sales. June durable goods orders headline and excluding transportation are expected to accelerate. Q2 GDP growth is reported on Friday with consensus, Atlanta Fed and NY Fed estimates at 4.3%, 4.513% and 2.69% respectively.
China reports June industrial profits with the May reading at 21.1% year-over-year.
The central banks of Ghana, Turkey, Hungary, Chile, Nigeria, Georgia, Russia and Colombia meet with Turkey expected to hike their policy rate by 1.0% to 18.75%. Most watched will be the European Central Bank meeting on Thursday, despite essentially no chance of a policy rate change. Rather investors will continue to listen for clues as to timing around any future rate increases – currently expected mid-2019.
Last week, the S&P 500 was little changed, but small-cap stocks regained their leadership. The 10-year U.S. Treasury yield moved higher to 2.89%. Developed international stocks were higher, while emerging fell by -0.5%. Despite lower oil prices, MLP stocks were almost 2% higher on the news of a more favorable FERC order.
2Q earnings season continues with 174 S&P 500 companies reporting. Last week, the financials rallied by over 2% and were the main driver of the increase in the overall earnings growth rate. S&P 500 earnings and sales growth are expected to remain robust at almost 21% and over 8% year-over-year respectively. With 17% reporting so far: 87% and 77% of companies beat earnings and sales respectively. Setting aside last quarter, earnings are on pace to grow at the fastest rate since Q3 2010!
Upcoming appearance with the CFA Society of Philadelphia on Thursday, July 26
at 6:00 PM: Do collectibles belong in your investment portfolio? I will present my thoughts and research on the valuation of art, stamps, violins and wine. The presentation will have you thinking about how these "emotional assets" hold value over time and what other costs are associated with them. Click here to register.
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