Retest Is One Of Many Scenarios
The big picture still looks good relative to the S&P 500’s breakout from a multiple-year consolidation pattern (see below). In terms of common action after breakouts, price often (not always) wants to retest the breakout area. The market will make the call over the next few days. The potential significance of the S&P 500’s breakout was outlined on July 12.
Stocks Make Progress Versus Bonds
The S&P 500 vs. intermediate Treasuries (IEF) chart below has cleared two hurdles this week: (1) the thin downward-sloping blue line, which dates back to the S&P 500’s 2015 peak, and (2) the multiple-month consolidation box. The longer those breakouts remain in place, the higher the odds the S&P 500 will hold its breakout above 2,134.
The S&P 500 vs. long-term Treasuries chart has not cleared the hurdles described above. Both charts remain helpful in terms of the sustainability of the bullish breakout in equities.
Energy Testing Overhead Resistance
If energy stocks (XLE) can break out from what may be a consolidation/bottoming process, it would also improve the bullish case for the broader stock market. For now, XLE is still below an area of potential resistance.
Total Debt Is Much Worse Than 2007
Global debt levels have increased at a rapid rate since the financial crisis. Debt, of course, has to be taken in the context of an economy’s ability to generate value. From Mauldin/Dillian:
The US has a 103% debt-to-GDP ratio. It’ll go up a lot under either Trump or Clinton. Italy’s debt to GDP is about 170% or so; Japan is at 240%. There really isn’t any chance that Japan is going to pay you back, or Italy, or even the US, once you take out-of-control entitlements into account.
Default, Extend And Pretend, Or Inflate
Debt has been and continues to be a well-known problem, and yet, it just seems to keep growing and growing. The easiest way to reduce the economic drag from bloated debt is to grow your way out of the problem. For numerous reasons, that has proved to be a difficult task.
If growth does not pick up, there are three major ways to deal with debt: (1) default, (2) extend and pretend, or (3) inflate. From Mauldin/Dillian:
Nobody is going to default here. You want to talk about Financial Armageddon… that would be it. Greece hasn’t had a lot of luck with extending and pretending. They’re in this sort of endless depression. I doubt anyone would want to copy them. Nope, everyone is going to inflate, which is the stealth way to default. There has already been open discussion about helicopter money in Japan (essentially the BOJ retiring or canceling outstanding debt).
Central Bankers And The Law Of Diminishing Returns
This week’s stock market video looks at how we got to this point and what are the possible next moves from global central bankers. The video takes a detailed look at the economic limitations of zero rates, QE, and helicopter money.
What Is The Market’s Current Read?
When the Fed was talking about entering a traditional interest rate hiking campaign, the markets were having difficulty coming to grips with a rising inflation scenario. However, once the Fed flipped the interest rate playing field in the first half of 2016, inflation-protection assets started to catch a bid. Notice gold started to turn just as the Fed backed off their “four rate hikes in 2016” stance (late January-early February 2016).
Does The Market Feel Inflation Is Imminent?
Given the look of the charts for long-term Treasuries (TLT) and intermediate-term Treasuries (IEF) below, the markets do not appear to be overly concerned about inflation in the short run.
However, like anything in the markets, that tame read on inflation is subject to change in the coming months; something we will continue to monitor closely.
Stocks, Bonds, And Gold All Holding Up Well
The mathematical readings from our market model for stocks, bonds, and precious metals all reflect bullish trends. The demand for all three assets classes aligns with an expectation that central banks will continue/expand their ultra-dovish policies (good for stocks and bonds), along with a growing acceptance that inflation/currency debasement may be the preferred long-term approach to deal with overwhelming global debt levels (good for gold and silver).
The Fed Who Cried Wolf
Just weeks after Janet Yellen outlined a new normal marked by low rates, the chatter has started about hiking again as early as September. Are investors buying it? Not really, the market, as of 10:30 am ET Tuesday, is pricing in an 81% probability the Fed does nothing at their September meeting.
A Logical Question
Casual market followers, along with many seasoned Wall Street veterans, may have recently had an internal voice ask:
What the heck is going on in the financial markets?
The short answer is everything we have come to know over the past 20 years about the latter stages of economic, interest rate, and market cycles, changed in early 2016. The shift is clearly evident in the odd behavior seen across numerous asset classes, which the tweet below captures:
The tweet above basically says stocks and bonds simultaneously experienced record-inducing demand. Is it uncommon for stocks and bonds to rise together? No, in fact it is quite common. The extremely rare part of the equation is that maximum confidence (new record high in growth-oriented stocks) occurred, for the most part, simultaneously with maximum fear (new record low in bond yields). Common sense tells us that maximum economic confidence and maximum economic fear should not occur in the markets on the same day, but that is exactly what happened on July 8.
How Did The Market’s Narrative Change In 2016?
After all the 2016 New Year’s confetti was cleaned up, the Federal Reserve was talking in a very unfriendly tone from an asset price perspective, as evidenced from the January 6 headline below (full Reuters story):
The Fed’s intention to raise rates as the economic data improved fits the script we have all come to understand over the past 20 years. Often bull markets and periods of economic growth come to an end after the Fed hikes rates a few times in an effort to keep inflation in check (or to restock their policy toolkit).
January 2016: Market And Fed Were Following Traditional Script
All things being equal, the financial markets frown upon Fed rate hikes. The S&P 500 responded to the hawkish and “old-script” Fed with the worst ten-day start in U.S. stock market history. During the January plunge in risk assets, the financial markets were reading from the deflation/weak economy/bear market script, as depicted by the chart of silver relative to defensive Treasury bonds below.
Today, the same silver:bond ratio looks quite a bit different, reflecting the market’s reaction to the Fed’s new and recently communicated late economic cycle script.
Debt, Helicopter Money, And The Fed:
This week’s video expands on the concepts covered in this post. How did we get to a point where central banks are seriously talking about helicopter money? What does it mean for the markets and investing?
Debt And Valuations Make Raising Rates Difficult
Why has the Fed adopted a new late economic cycle script? Given extremely high levels of global debt and elevated valuations, central bankers are terrified of inducing anything remotely approximating a Japan-like deflationary spiral. The Fed is concerned if they follow the traditional late-cycle script, asset prices could experience a significant and sharp reset, which could ignite a wave of bond defaults and/or a recession. From the Los Angeles Times:
Eight years ago, unsustainably high debt was the root cause of the worst recession since the Great Depression. Yet, world debt overall now is far above 2008 levels…The overstretched include plenty of governments. Total government debt outstanding worldwide was worrisome in 2008. It has since doubled to $59 trillion, according to Economist Intelligence. But that is just one slice of the global debt pie. Add in household, corporate and bank debt and the grand total was a mind-boggling $199 trillion in mid-2014, up 40% since 2007, according to a study last year by McKinsey Global Institute.
Inflated Asset Prices Reacted To Threat Of Rate Hikes
The Fed was given a taste of what a global reset might look like after they raised rates in late 2015. The S&P 500, as of January 20, 2016, is shown below.
What Markets Were Anticipating In Early 2016
For illustrative purposes, the S&P 500 is shown below from 1997 to 2004. The old script says central banks raise rates near the end of a bullish cycle (1999); the economy eventually slows, and risk markets eventually fall (2000). Sometime during the bearish/recessionary period that follows, the Fed starts to ease policy again (2001) and eventually a new bullish cycle begins with an improving economy and a new bull run in risk assets (2003).
How Did Central Banks Flip The Playing Field?
After the Fed’s early 2016 deflationary spiral scare, central banks slowly started delivering a message that they have gone down a policy road (zero/negative rates) that is very difficult to reverse using the traditional late economic cycle playbook.
The dated headlines below, along with links to each article, illustrate the shift that took place between early January 2016 and the present day. The first headline aligns with the traditional late economic cycle script. The last headline aligns with the new “too much debt and valuations say asset prices are vulnerable” late economic cycle script.
The Fed Saw The Writing On The Asset Price Spiral Wall
Experienced investors would quickly label the January 2016 S&P 500 below as a “possible head-and-shoulders topping pattern”. Bull markets often end when earnings slow, valuations become extended, and stocks move sideways for a long-period of time. All three were in play early in 2016, which makes it easier to understand why the Fed shifted abruptly from “four hikes in 2016″ to “helicopter money should be in our toolkit”.
A Major Bottom Near A New All Time High?
The Fed’s flip flop on rates helped spark the current rally in stocks, which put the mini deflationary spiral fire out. Recently, pre-and-post Brexit and ultra-dovish comments helped markets come to grips with the fact that the central banks plan to extend their zero/negative rate policy experiment further, rather than reign it in as the Fed indicated in January. A July 12 article referenced an extremely rare breadth event that occurred as central banks communicated their asset-price-escalation game plans. The rare event was described via SentimenTrader’s tweet below:
In the chart/tweet above, notice the last time the rare breadth event occurred; in early 2009 after an incredible amount of bear market related stimulus had been announced (green arrow). The 2009 bottom in stocks fit into the traditional market and interest rate cycle script (stimulus came during the bear market/recession and helped create a new bull market/expansion).
Trying To Create A Major Bottom From A Major Top
As pointed out by @DowdEdward (see tweet below), notice how the first breadth event occurred near a major market low (green arrow); a low that was assisted greatly by central banks and government bailouts/stimulus. The second occurrence in 2016 (blue arrow) also followed talk of possible bank bailouts in Europe and even more stimulus from central banks. The big difference is the first rare occurrence happened near a major market low (green arrow) and the second rare occurrence took place in the context of what appeared to be a traditional end of a bull market topping pattern in stocks (blue arrow).
Central Banks Scratching And Clawing In An Attempt To Avoid Deflationary Spiral
The concept of creating a “bottom near a top” is exactly what global central banks are trying to engineer. They keep hoping the next batch of rate cuts, money printing, asset purchases, etc. will create sustainable economic growth, allowing earnings to catch up to artificially propped up asset prices. Central planners hope the next “wealth effect” program will allow them to grow their way out of the zero/negative rate mess they have created over the past nine years. If their grand policy experiments fail, central bankers will lose a considerable amount of power.
Helicopters Dropping Money?
In the United States, the Federal Reserve has gone from “four rate hikes in 2016” to “we should have helicopter drops” in our policy toolkit. With Janet Yellen and FOMC member Loretta Mester both having talked about helicopter money within the last thirty days, more and more market participants are coming to the conclusion that it is highly unlikely the Fed has entered a traditional late-cycle campaign to raise interest rates, but instead the next two or three policy moves could push the Fed’s already hyper-dovish stance into maximum hyper-dove mode. From Australian Broadcasting Corporation:
Dr Loretta Mester, president of the Federal Reserve Bank of Cleveland and a member of the rate-setting Federal Open Market Committee (FOMC), signaled direct payments to households and businesses to stoke spending [a helicopter drop] was an option central banks might look at in addition to interest rate cuts and quantitative easing. “We’re always assessing tools that we could use,” Dr Mester said in response to a question from the ABC about the potential use of helicopter money.
Japan Is Already In Near-Helicopter Mode
The Bank of Japan has a policy statement due to be released on July 29. The financial markets will be looking for additional stimulus. From a July 14 Bloomberg story:
Etsuro Honda, who has emerged as a matchmaker for Abe in corralling foreign economic experts to offer policy guidance, said that during an hour-long discussion with Bernanke in April the former Federal Reserve chief warned there was a risk Japan at any time could return to deflation. He noted that helicopter money — in which the government issues non-marketable perpetual bonds with no maturity date and the Bank of Japan directly buys them — could work as the strongest tool to overcome deflation, according to Honda. Bernanke noted it was an option, he said.
“There’s a strong allergy to so-called helicopter money in Japan, though the definition of the word differs from person to person,” Honda said in an interview on Wednesday. “While looking at the BOJ’s bond purchases and fiscal policy as a package, which I see as a kind of helicopter money, it would be beneficial if the prime minister understands that there is a global leading scholar clearly advocating helicopter money,” said Honda, who was speaking by telephone from Switzerland, where he is serving as Japan’s ambassador.
The markets may not get a textbook helicopter plan from the Bank of Japan on July 29, but the degree of accommodation may be in the same money-printing ballpark. From Bloomberg:
Ben S. Bernanke earned the nickname “Helicopter Ben” for once suggesting a central bank could overcome deflation by cranking up the money presses to finance tax cuts. He’s always made clear such efforts would be a last resort, the equivalent of dropping money from the sky. So when the former Federal Reserve chairman arrived in Tokyo for talks with Japan’s top policy makers this week, bond traders, stock investors and economists had reason to wonder. Was Shinzo Abe’s economic team (Bank of Japan) ready to break the glass, pull the emergency lever and entertain such a radical shift in policy as direct fiscal financing by the central bank. While officials Wednesday played down the most extreme scenario, two of Abe’s top advisers did call for a double-barreled blitz of coordinated fiscal stimulus and money printing.
Why Is There Too Much Debt?
There are numerous reasons, but extremely low interest rates and debt bailouts are a good place to start. Recessions, like other processes in nature, help identify weak players in the public and private sector. During recessions, the rate of bond defaults increases, which is a natural way to purge bad debt from the global economy. The problem is central planners have pumped up asset prices to such lofty and artificial levels, central bankers fear that letting economic natural selection into the debt purging process could set off a hard to stop deflationary spiral in asset prices. Below are just a few examples from the central planning bailout collection:
More Bailouts Coming In Europe?
When policy makers continually prevent major debt defaults via bailouts and keep interest rates near zero, the global debt mountain just keeps getting bigger and bigger. The problems are still with us in 2016. Europe is currently debating how to prevent zombie banks from defaulting; some are calling for a $166 billion dollar bailout. From The Wall Street Journal:
Nowhere is the risk concentrated more heavily than in the Italian banking sector. In Italy, 17% of banks’ loans are sour. That is nearly 10 times the level in the U.S., where, even at the worst of the 2008-09 financial crisis, it was only 5%. Among publicly traded banks in the eurozone, Italian lenders account for nearly half of total bad loans. Years of lax lending standards left Italian banks ill-prepared when an economic slump sent bankruptcies soaring a few years ago.
Helicopters And Paper Currencies
How confident would you feel about the cash in your wallet if global central banks started making direct payments to households and businesses or simply printing money to retire government debts? The answer may help us understand why investor demand for hard currencies (gold, silver) has increased substantially as more and more serious chatter emerges about fueling up the money-drop helicopters. From CFA Institute:
Why has the post-crisis recovery been so disappointing? … Are we stuck in a world of diminished prospects and subdued demand? These were the key questions Lord Adair Turner, chairman of the Institute for New Economic Thinking and author of Between Debt and the Devil… “Debt has become unsustainable across the world,” Turner explained… “The trouble is,” Turner explained, “once we have these cycles of credit, asset prices, more credit, if we then get a swing from the exuberant upswing to the depressive downswing, if we get that when leverage is already high, we seem to enter an environment where the leverage never actually goes away. All it does is move around the economy.”
Debt is never paid down, in other words. It’s only shifted: from corporate debt to public sector debt, from advanced economies to emerging markets, and so on. Citing both Milton Friedman and Ben Bernanke, Turner proposed “helicopter money,” or what he prefers to call “overt monetary finance of increased fiscal expenditure.”
“You can use central bank money to finance tax cuts or expenditure increases in a fashion that does not require the government to borrow money,” he explained. “Or you can monetize existing government bonds. Central banks can buy existing government bonds and simply write them off, which frees up the government to run larger fiscal deficits in future.”
How Long Will The Prop-Up Approach Work?
Only markets can answer that question. However, history tells us that central banks tend to experience waning effectiveness when economic data begins to hint strongly at a recession (especially a U.S. recession) and/or when inflation starts to become a problem. Given recent economic data in the United States is not warning of an imminent recession, and inflation trends around the globe do not fall into an elevated category, the prop-up asset prices strategies have continued to be respected by the markets (see vertical ascent in stock prices off the Brexit lows).
Buying Bonds Is Not Supposed To Be A Risk-Free Proposition
It may be hard to believe, but there was a time when a poorly run company or country couldn’t make ends meet, they were allowed to default on their debt. When investors buy stocks and invest in bonds, it is not supposed to be a risk-free proposition. Bond defaults are part of the risk-reward equation, or at least they used to be. And yet, we hear more and more policy makers complain about too much debt in the system; maybe they should take a look in their never-ending bailout mirrors.
The data and image above from the Los Angeles Times (full article here).
Negative Rates Are Sending Common Sense Messages
Interest rates are set in the marketplace based on the supply and demand for money (credit). When rates are near zero or negative, it is the market’s way of saying the demand for new credit is incredibly low relative to the availability of credit. If demand for new credit was high, then lenders would have the power to charge higher interest; they do not have that power today. Zero/negative interest rates are a strong and incredibly clear signal to central banks and policy makers that the “wealth effect” approach has been pushed well beyond its useful life.
We Have Arrived At The End Of Reason
The wealth effect approach has been pushed beyond the bounds of economic common sense, and yet, instead of saying enough is enough, we may be on the verge of becoming very familiar with the term helicopter money. The tweet below from @ReformedBroker sums up just how far off track global central planners have taken the financial markets and global economy.
A Period Of Asset Price Desperation
Central banks are already buying stock-based ETFs and corporate bonds, as outlined on May 11. When serious talk of dropping money from helicopters and fear of “growth causing a recession” enters the equation, it becomes crystal clear that central banks are on the doorstep of asset price desperation.
After A Failed Breakdown, Stocks Broke Out
In what is a microcosm of the last two years, the S&P 500 broke below its recent trading range roughly two weeks ago. The bearish breakdown quickly turned into a failed breakdown as stocks reversed and shot back up in a vertical manner.
Big Moves Have Come In Both Directions
As a reminder of how quickly things can change in the present day markets, it may seem like a distant memory, but the S&P 500 was in negative territory for 2016 just a short time ago.
A Break Above The Box
The S&P 500’s recent breakout, thus far, is impressive. Since stocks have been moving inside a box for over two years, a significant push above the box is quite possible based on the expression “the longer you go sideways, the bigger the move you can get once a breakout or breakdown occurs”.
1994: An Anecdotal Example
While we understand 1994 is a significantly different period relative to 2016, 1994 can be used to illustrate the generic concept of a long-term consolidation in stocks.
What Happened Next?
Once the multiple-year logjam was broken in early 1995, stocks rallied over 39%.
Is there anything else, other than the 2014-16 consolidation box, that indicates the 2016 breakout in the S&P 500 could have some serious upside legs? Yes, the tweet below from Sentimentrader outlines another in a long line of rare stock market occurrences that we have experienced in the last two years. Prior to the last ten trading sessions in 2016, the market stat described below had occurred only once in the last 20 years. Now we have two examples. The last time it happened, very good things happened in the stock market.
These 2016 Charts Can Assist With Probabilities
Hypothetically, if 2016’s breakout from the stock market box were to be followed by a double-digit push higher, the odds are very good the chart below would do two things: (1) break the pattern of lower highs (see orange arrows), and (2) break out above the top of the box. Those things may happen, but they have not happened yet.
The ratio of stocks to intermediate-term Treasuries paints a similar picture. Compare and contrast the look of the blue boxes on the S&P 500 chart and the two stock/bond ratio charts; all three charts cover the same time period.
How Can We Use This?
Do the charts above negate the S&P 500’s impressive breakout this week? Absolutely, positively, no. The stock/bond charts have additional confidence hurdles that we can use as guideposts. If the stock/bond charts break out, it will increase the odds of (a) the S&P 500 holding its bullish breakout and (b) additional upside in risk assets. Conversely, if the stock/bond charts retain their hesitant look, we can continue to approach the stock market’s breakout in a prudent and measured manner.
Is This A Bearish Analysis For Stocks?
No, it is a bull/bear probability analysis. The stock/bond ratios can help us with bullish probabilities and bearish probabilities. Also, it is difficult to label the 1994 example as bearish.
Broad Stock Market Back To Familiar Area
While the S&P 500 (SPY) was able to push to a new high during Monday’s trading session, the broad NYSE Composite Stock Index (VTI) was still looking for a close above an area that acted as resistance in the past.
Are Stocks Set To Rocket Higher?
This week’s video looks at the narrative for stocks breaking out and pushing higher, as well as the impact of slowing credit growth on asset class behavior.
Stocks vs. Bonds Near Key Trendline
Like the NYSE Composite, the ratio of the S&P 500 (SPY) to a diversified basket of bonds (AGG) was testing a key area Monday. If the ratio can push above the downward-sloping blue trendline, it would be a positive development for stocks relative to bonds. Conversely, if the ratio fails to push/hold above the blue line, it increases the odds that Monday’s stock breakout may be followed by relatively tepid price action.
Defensive/Hybrid Assets Post NFP
Bad Loans In Italy A Big Problem
The U.K.’s recent vote to leave the EU has shed some additional light on existing weak spots in the European economy. One of those weak spots is Italian banks. From The Wall Street Journal:
Britain’s vote to leave the EU has produced dire predictions for the U.K. economy. The damage to the rest of Europe could be more immediate and potentially more serious. Nowhere is the risk concentrated more heavily than in the Italian banking sector. In Italy, 17% of banks’ loans are sour. That is nearly 10 times the level in the U.S., where, even at the worst of the 2008-09 financial crisis, it was only 5%. Among publicly traded banks in the eurozone, Italian lenders account for nearly half of total bad loans.
Some Calling For More Bailouts
The EU has formal dos and don’ts when it comes to assisting financial institutions. A dialog is taking place about those rules. From Bloomberg:
Italy’s banking crisis could spread to the rest of Europe, and rules limiting state aid to lenders should be reconsidered to prevent greater upheaval, Societe Generale SA Chairman Lorenzo Bini Smaghi said. “The whole banking market is under pressure,” the former European Central Bank executive board member said in an interview with Bloomberg Television on Wednesday. “We adopted rules on public money; these rules must be assessed in a market that has a potential crisis to decide whether some suspension needs to be applied.”
The term “backstop” is the politically correct way of saying bailout, something that may not be welcomed by taxpayers, especially given the current tone of the electorate. From Bloomberg:
Bini Smaghi said on Bloomberg TV that Europe’s banking market faces the risk of a systemic crisis unless governments accept the idea of taxpayer money as the ultimate recourse. Any intervention should be as swift as possible, he said. Both Italy and Germany have too many banks that are not profitable and more consolidation is needed, he said. Italy must do more to deal with non-performing loans, and Prime Minister Matteo Renzi will have to take politically unpopular steps, including encouraging mergers that will lead to job cuts, Bini Smaghi said. “What’s needed is a European solution,” he said. “So far, we’ve had national solutions. We need a clear backstop.”
Brexit Brings More Uncertainty
The fact that Italian banks are carrying an alarming amount of non-performing loans on their books is not particularly new. However, Brexit exacerbates concerns related to future economic outcomes. From CNBC:
“The U.K.’s Brexit referendum has injected greater uncertainty into European growth forecasts, including Italy’s. That in turn has created worries about higher loan losses at the country’s banks, coupled with falling government bond yields that further hurt financial institutions’ margins. taly’s banking system is considered to be one of the most vulnerable in the euro zone with a high level of non-performing loans (NPLs) — estimated to total 360 billion euros ($400.7 billion) — overshadowing the sector.
Fears Of Brexit Contagion
Discussions concerning the possibility of “backstopping” Italian banks could lead to increasing questions about the benefits of staying in the EU. From CNN:
An Italian banking crisis, together with the Brexit vote, could inflame anti-European sentiment. Italians are already losing faith in the euro, and the clamor for a referendum on the currency is getting louder. Prime Minister Matteo Renzi is at risk of losing a vote this fall on constitutional reform. If he does, he may be forced to resign, leading to new elections at a time when Italy’s anti-euro party, the Five Star Movement, is gaining ground. “The traditionally very pro-European country has become more euro-sceptic after years of economic stagnation and painful fiscal repair,” wrote Holger Schmieding at Berenberg bank. “The risk of domino effects across the eurozone looms larger than before.”
During a recent visit to EU Parliament, George Soros expressed concerns about Europe’s entire banking system, which is one of the reasons asset class behavior had a decidedly defensive bias during last week’s rally in risk assets.
The Weight Of The Evidence
Looking at the stock market in isolation last week, it appeared “risk-on” was back in a big way. However, a peek behind the bull/bear curtain, painted a very different picture. From The Wall Street Journal:
After Lehman Brothers fell over in September 2008, equities slumped, then rallied back to their previous levels within a week. Brexit isn’t Lehman, but the stock market is behaving similarly…In 2008, shareholders made an epic mistake: They assumed Lehman would be manageable. This time the assumption is that central banks will ride to the rescue and corral any problems. Investors expect global easy money, adding yet another central-bank prop to the stockade protecting shares from weak economic growth. The result is some unusual, and worrying, behavior in the bond market. Since the Brexit vote, Treasury yields have tumbled, and they kept falling even as shares recovered.
Two Charts That Say A Lot About Confidence
During the financial crisis, demand for defensive Treasuries soared as economic and systemic concerns started to pile up. How have bonds performed relative to stocks since the Federal Reserve did an about face on interest rates in early 2016? The answer can be found in the two charts below.
Central Banks vs. Slowing Global Growth
This week’s stock market video takes a deeper look into asset class behavior during the Brexit rally in stocks. How did the inflation trade hold up relative to defensive assets? Did European banks participate in the risk-on rally? Why did stocks rally? What could derail the rally?
Equity Leadership During The Brexit Rally
Not only did bonds outperform stocks last week, but leadership on the equity side of the ledger was decidedly defensive as well. From The Wall Street Journal:
Last week’s divergence of bonds and equities isn’t healthy. Bond markets are screaming that the world economy is slowing, and shareholders have their fingers in their ears singing “la-la-la I can’t hear you.” Stocks are no longer about growth, but about a desperate search for safe alternatives to low-yielding bonds. Since Brexit, the bond-driven nature of the stock market has been particularly stark. Four sectors in the S&P 500 are now higher than they were on the eve of the British vote, and none are a bet on the American economy’s underlying strengths. Utilities, consumer staples, health care and telecommunications sell stuff people need even in bad times; this is a defensive rally, not a dash for growth.
Inflation Trade Lags
Inflation expectations derived from U.S. bonds are falling at precisely the same time that stocks have jumped, suggesting a “dangerous disconnect” between interest rates and equities, according to analysts at TD Securities Inc. “We believe that the equity market is complacent about the growth spillover from the uncertainty shock caused by Brexit, but is still pricing in monetary policy easing.”
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