April 24, 2018

Three is the Number

Today the US Treasury 10yr Note traded above 3% for the first time in nearly five years. This is a significant move for two reasons. First it’s a sign that the statistical measures of inflation are being taken seriously by the markets and that for the first time in recent memory the combination of stronger economic growth and higher interest rates make welcome the growth as well of some interesting opportunities to invest in bonds. It should also be mentioned that the Fed’s ambition to unwind some of their post crisis stimulus was expected to bring on a negative reception from the interest rate markets. But as usual when markets decline they uncover hidden treats and for now what is happening is not a surprise, at least when considering the following.

The Economy
The economy is growing. It’s not that strong except when compared to the years following the financial crisis when GDP growth stagnated around 1.5%. Now it’s around 3% and when adding in inflation is decidedly a growing economy. However, in light of the confirmation suggested by todays move in interest rates the past few weeks have also seen some slowing down in inflation as suggested by the
-.01% consumer inflation (CPI) data. On other recently strong fronts the slowdown, in spite of an intact positive trend, can be seen in Housing Starts (growing but from unstable sectors) , Manufacturing (growing but in recently depressed mining and industrial production only) Retail Sales (growing but erratic due to weather and seasonal factors) and I think you get the idea. As long as this trend continues the Fed could likely remain attentive, but the markets are a different factor.

The Markets
There are a number of behaviors inherent in the stock and bond markets that can be expected in the search of value and opportunities. First and foremost is that those markets don’t need help to move outside of the investing public. The move above 3% today was the bond markets impatience with waiting for the Fed to stop talking and start raising interest rates and in the meantime stocks will weaken until the bond market figures it all out. The former important because when the Fed does tighten, the only thing for interest rates to do then is, nothing, which is good for stocks. And the latter because broad markets will have given up some value to present some compelling opportunities.

External Events
This week’s move to smooth out trade tensions is being generally overlooked in favor of more biting news. Today’s decline in the markets driven primarily by steep drops in Google (GOOGL) and Facebook (FB) that will likely be followed up by the recent establishment of a privacy council for the European Union that is predictably going hard after the two companies. Issues with the upcoming meeting between the US and North Korean leaders shouldn’t have too much impact, except putting some weight on defense stocks should a deal be struck. And the only outlier is still China who has stepped up their ambition to serve their country with their own network of companies. Sound familiar? In my opinion I still think a deal will be struck as part of a broad trade deal (maybe even a revamped, more inclusive TPP) to help both China and their largest European partners in addition to the US. Any other issue of a political nature will have as much influence on the markets as they’ve had since they began.

Or should I say Bitcoin. The curious rebound in the prices of an array of crypto currencies just at the time the US and Euro Asian broad markets are correcting is no accident. We’ve written before the potential for a leading cryptocurrencies to replace singular defensive investments such as Gold and Fine Art and it would appear to be playing out in the past week. Appearances can be misleading, so I’ll keep everyone updated.

Down the Road
The challenges of the broad markets are in my opinion the same as they’ve been since last year. The increased level of growth has, I believe, caught the Federal Reserve by surprise and pushed their agenda to include an additional rate hike in this year. Economics, as we analyzed, don’t necessarily suggest the same level of strength coming down the road. That doesn’t mean the economy will sink, or the yield curve will follow by inverting (sometimes considered a precursor to recession) it more likely suggests a period of static change, especially with so much happening on the trade front, and our entering into the spring and summer season. There is notion that it is wise to sell in May and go away for the summer. We’ve already sold a little to slow down and take in the scenery, but believe the opportunity to speed up will be on the horizon.