It has been said there are two sides to every story. Just look at world financial markets. Stock markets and bond markets are telling very different stories.
In the United States, stock markets were blue ribbon winners last week.
The Standard & Poor’s 500 Index rebounded to a record high. The Nasdaq Composite also set a new record. Barron’s reported U.S. stock markets were supported by abundant optimism inspired by expectations for solid earnings growth and a Federal Reserve rate cut in July.
Optimism pushed stocks higher in Europe last week, too. CNBC reported investors were receptive to news suggesting the European Central Bank would ease monetary policy to support the European economy. A significant number of national stock indices in Europe, the Middle East, and Asia finished last week higher, according to Barron’s.
Bond markets have been telling a less optimistic story.
In many regions of the world, bond yields have sunk below zero, and bond buyers have been locking in losses by investing in bonds with negative yields.
In the United States, the 10-year Treasury yield remains positive, but it has dropped from 3.2 percent in November 2018 to 2.1 percent at the end of last week.
So, what are bond markets saying? Barron’s suggested some possibilities:
“…bond buyers locking in subzero yields aren’t doing it, of course, for love of losses. They might think that the certainty of small losses will prove a better deal in the years ahead than whatever stocks provide…There’s something else that negative yields could be telling us. Investors need bonds for things like diversification and setting aside money at known rates to offset known liabilities. For an investor who must buy bonds, a purchase here with negative yields isn’t necessarily a bet against stocks. It could just be a wager that bond yields won’t get much better – that slow growth and meager inflation will loom for many years.”
Time will tell.
Did last week mark the start of a new policy for the Federal Reserve?
The U.S. Federal Reserve has a reputation for providing little transparency about the timing and direction of potential rate changes. That reputation was challenged last week.
In back-to-back speeches, two of the three most influential members of the Federal Open Market Committee (FOMC) – Federal Reserve Vice-Chairman Richard Clarida and Fed Bank of New York President John Williams – made a case for lowering the Fed funds rate to support economic growth, reported Financial Times.
When asked about Fed officials’ comments, a currency strategist cited by Financial Times said, “…the communication we received seemed in many ways to be a coordinated attempt to signal the market given its timing and context…”
The magnitude of the change remains a mystery. Barron’s reported debate remains over whether the Fed will cut rates by 0.25 or 0.50 of a percentage point. On Saturday, the CME FedWatch Tool reported a 77.5 percent probability of the former.
There was some positive economic data last week, including an uptick in U.S. consumer spending and positive manufacturing data from the Philadelphia Fed’s July survey, reported Barron’s. However, the Conference Board Leading Economic Index® declined, indicating growth may remain slow during the second half of the year. The index combines 10 individual leading indicators in an effort to reveal patterns in economic data.
The Standard & Poor’s 500 Index was down 1.2 percent last week.
The bulls are running.
Last week, the Standard & Poor’s 500 Index set a new record, closing above 3,000 for the first time. Other major U.S. stock indices also finished at record highs, reported Barron’s.
Company fundamentals, investor sentiment, and geopolitics all have the power to push stock prices higher. However, according to Financial Times, last week’s gains were attributed to Federal Reserve Chair Jerome Powell’s testimony before Congress and the expectation the Federal Reserve will lower the Fed funds rates in July.
Financial Times reported:
“Mr. Powell laid out the case for monetary easing by highlighting some softness in indicators such as business fixed investment and persistently low inflation. But mostly, he stressed the impact of uncertainty stemming from trade tensions, weak global growth, the possibility that the U.S. Congress fails to raise the debt ceiling, and a no-deal Brexit.”
Investors were encouraged by the possibility of monetary easing. Yardeni Research charted data showing the Investors Intelligence bull/bear ratio rose to 3.1 on July 9. It was 2.94 on June 25 and 3.05 on July 2, which indicates bullishness has been increasing.
An Investors Intelligence bull/bear ratio greater than 1 typically indicates high levels of bullishness, while a bull/bear ratio of less than 1 typically indicates high levels of bearishness. The ratio generally is considered a contrarian indicator, explained Investing Answers.
Year-to-date, the Standard & Poor’s 500 Index is up 20.2 percent.
What will the Federal Reserve do now?
There was unexpected economic news last week. On Friday, the Bureau of Labor Statistics announced 224,000 new jobs were added in June, which was more than analysts had anticipated. The gains were offset a bit by reductions in April and May employment estimates. However, overall, the pace of jobs growth during second quarter was fairly consistent with jobs growth during the first quarter, reported Matthew Klein of Barron’s.
Strong employment numbers invigorated some investors. As a result, the Standard & Poor’s 500 Index, Dow Jones Industrial Average, and Nasdaq Composite finished the week near record highs.
Not everyone was jumping for joy, however.
The performance of the bond market continued to indicate some investors are worried about the possibility of recession. The yield curve remained inverted last week with the 10-year Treasury note trading at lower yields than 3-month Treasury bills. Yield curve inversions have been harbingers of recession in the past, reported Ben Levisohn of Barron’s.
Time may provide greater clarity about the strength of the American economy. April Joyner of Reuters reported,
“It will likely take several months of economic data - along with results from the corporate earnings season later this month - to clarify the picture, investors say. In contrast to Friday’s upbeat employment report, data earlier this week showed U.S. manufacturing and service activity in June declined to multi-year lows… Future data…may end up either confirming recession fears or altogether dashing the hopes for interest-rate cuts that have buoyed stocks.”
In its July meeting, the Federal Reserve will examine economic data and decide whether to lower rates. Investors have been anticipating a rate cut, reported Greg Robb of MarketWatch. If it doesn’t happen, stock markets could be a bit volatile.
In the infamous words of Mortimer Snerd, “Who’d a thunk it?”
After U.S. stocks dropped sharply during the last weeks of December 2018, investors were not optimistic about the future. Early in January 2019, the State Street Investor Confidence Index dropped to its lowest point since 2012, and the American Association of Individual Investors (AAII) Sentiment Survey showed just about 31.6 percent of investors as bullish. The long-term average for bullishness is 38.2 percent.
How things have changed!
The Standard & Poor’s 500 Index finished the second quarter up about 17 percent year-to-date, according to Ben Levisohn of Barron’s. The index gained 6.9 percent in June, its best performance since 1955.
Stocks weren’t the only market delivering gains. Bond markets did well, too. Corrie Driebusch of The Wall Street Journal reported the yield on 10-year Treasuries finished the quarter at 2 percent. That was significantly below its yield at the end of March 2019. Remember, when bond yields fall, bond prices rise.
The strong performance of both markets owes much to changing policies at the Federal Reserve. Randall Forsyth of Barron’s reported,
“The first half of 2019 was terrific for financial markets, regardless of whether you were a stock or bond investor…a good first six months largely reflects the pivot by the Federal Reserve from its stance last year, when it indicated that it would raise short-term rates multiple times. In early January, Fed Chairman Jerome Powell said the central bank would be “patient” in boosting rates and then, in late spring, shifted to indicate that the next move is likely to be a cut.”
Stocks didn’t follow a steady upward trajectory during the second quarter, reported Forbes. Signs the U.S. economy could be softening combined with trade tensions between the United States and China caused major U.S. indices to lose ground in May before climbing higher again in June.
On Saturday, following the G20 Summit – a confab between leaders of 19 countries and the European Union, as well as representatives from the International Monetary Fund, and the World Bank – China and the United States agreed to restart trade talks, reported Reuters. President Trump indicated current tariffs on China will remain in place, but additional tariffs will not be assessed, according to CBS News.
While it appears to be positive news, managing director of the International Monetary Fund Christine Lagarde stated, “While the resumption of trade talks between the United States and China is welcome, tariffs already implemented are holding back the global economy, and unresolved issues carry a great deal of uncertainty about the future,”
Last week, the S&P 500 was down slightly, as were yields on 10-year Treasuries.
Hold onto your hats. We could see some volatility during the second half of the year.