'Treasuries vs Stocks' standoff continues.

Thursday, 15th November 2018 07:14 - by Shant

Monday was a holiday-thinned session with North America observing Veteran's day, and even though the Wall Street equities were open, the bond markets were shut. 

This made for an interesting open on the following Tuesday after the start of the week saw the major indices posting some heavy losses, headlined by a 600pt drop in the Dow, though the S&P gives us a better representation given the broader coverage and here, losses were close to 55pts - so around 2%.   Despite the heavy tone, market pundits are unconvinced that this is a major turnaround, and who can blame them given the undisturbed bull run we have seen since late 2011.  

We have seen periodic shakeouts throughout, however, most notably at the start of 2016, when at the time, Oil prices collapsed and eventually hit lows around $25 a barrel.  It should not have gone unnoticed that we have suffered a sharp fall in the black stuff this week, having dipped under the $55.0 in NY trade Tuesday night.  The parallels are inconsequential as far as I can see as yet, especially when you consider outright levels and the lack of a clear catalyst.  OPEC members including Saudi Arabia are intent on cutting back production, so many are at a loss as to why the move has developed to the degree it has.  What explanations there have been point to reduced demand, and this view does carry merit when considering some of the major importers such as Germany and Japan have reported vastly reduced levels of industrial production in recent months - with trade tensions behind this for the most part. 

President Trump's call for Saudi to increase production and lower prices looks to be a feeble reason to attribute to this, while continued USD strength may also have played its part.  Indeed, Dollar strength has been a key factor in distress seen across a range of markets, most notably the emerging markets and commodities.  

Despite the cautious risk mood, we continue to see Gold shunned despite its traditional safe-haven status.  Cash US Dollars are king at the moment, and this has caused mayhem for those looking to hedge through the familiar channels of old.  Sellers of Gold in the futures market are taking advantage of US Dollar carry, in what looks to be a disturbing sign over overleveraging yet again.  End of year profit taking and rollovers may reveal more on this.  However, as already stated, bond markets were shut on Monday, and the following day, there was little reaction to the stock market sell-off.  It seems fund managers are not quite ready to throw the towel in on the bull run, and buying Treasuries into the current Fed rate path is undesirable as yet, so curve inversion is being staved off for now.  

What will be more interesting to see is more of the consumer data, with October retail sales out on Thursday and this should give us some fresh insight into whether the tax cuts are starting to wear off.  Much has been made of this tailwind, and if the US data starts to fade, then it all starts with spending.  Income levels have been consistent if not slightly lethargic when measured against the job gains and more importantly, the ongoing openings for skilled workers.  I would argue that wage growth has been somewhat disappointing in relative terms, and this was tentatively borne out in the lower than expected real earnings in Wednesday's inflation report.  Core inflation eased off slightly while headline CPI moved back to 2.5%.  The latter is likely to soften again unless Oil prices post a notable turnaround and Dollar gains are tempered.  

Nevertheless, signs of a slowdown in the US data are starting to play out as anticipated, and this confluence with recent stock market losses could develop into something more significant.  The only thing we can see which can arrest the current nervousness in the market is perhaps an earlier pause in the tightening cycle.  This looks unlikely based on established forward guidance. If so, the dynamic should change to outright demand for  Treasuries.  Either way, the odds for fresh highs in US stocks are dwindling and this could change the narrative towards a bear market.  

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.