National Post (National Edition)
News still isn’t good for yield curve
No magic wand for instant relief, either
Iwish folks would stop asking why the market is going down and instead ponder what it was that took the major averages up so sharply from January to July — especially since we know for a fact that earnings and earnings forecasts have been going down all year long. A multiple-led market rally built on a set of assumptions that proved mistaken actually fully deserves to unwind. So when the bulls say that, “Hey, we’re still up 13 per cent for the year,” the bears will respond, “Exactly.” There is still a tremendous amount of air under this thing.
People ask me whether this downdraft will end soon and bounce just as we experienced last December. It is so incredible when you think about it. A 19-per-cent plunge in last year’s fourth quarter that bottoms out and quickly surges. And then lulls the unsuspecting souls back into the market as the major averages hit new all-time highs. How cruel. But this time — what will the rabbit out of the hat be? There is no more Fed tightening to price out. There is no more government shutdown to end. There is no Chinese stimulus
coming, at least not soon. And no chance of a trade deal before the 2020 election despite the ongoing charade of trade talks.
The bulls say this is a repeat of 1998 because the comparison they used to make was 2016 and that no longer holds water. Just as the bulls loved to cling to the view that nobody should worry because the 2-year/10year yield curve hadn’t inverted yet. Now that it has (briefly), they have shifted their focus to 10-year/30year and are also saying that yield curves aren’t infallible after all, or are leaning on Janet Yellen, who incredibly asserted that it is different this time. Or, of course, all the pundits who say “don’t worry, be happy” because of the classic lags between the curve inversion and the recession and peak of the market cycle. Little mention that segments of the Treasury curve actually began to invert last November.
The message from the long-bond yield is unmistakable that a recession is coming — slipping below two per cent this past week for the first time ever. It isn’t about the yield curve. Japan has had multiple recessions without an inversion and the euro did this cycle as well. It’s a complete ruse. These economists and strategists would be wiser to instead assess the message that these market signals are sending.
As everyone debates the veracity of the yield curve yet again, everyone should know that you don’t need an inversion to move into recession. That said, its 85-per-cent track record in predicting recessions and expansions is pretty darn good. And even Janet Yellen and others like her who feel the yield curve is a “less good” barometer today, should know that we heard much the same thing from many pundits in 2000 and 2007. The thing is about the yield curve, and maybe it’s just pure luck, but every recession in the post-Second World War era was preceded by an inversion. Go figure.
At the very least, flat or inverted yield curves impair banking sector profitability and curtail the incentive to extend credit — so right here, through this channel alone, the pace of economic activity slows down. That’s the major point, with or without an actual NBER-defined recession — it’s still going to feel like one!
So guess what? We have another classic savings glut on our hands, of a similar nature that Ben Bernanke was lamenting back in 2006. For those folks who want to know why global interest rates are melting, I can tell you that it is not rocket science. We have a deficiency of investment and a surplus of savings. Interest rates will always be moving down when global savings exceed global investment. And that’s what is happening and the differential between the S-curve and the I-curve is expanding. This gap is creating the conditions for this ongoing decline in yields.
Then we must consider what a recession will do to Donald Trump’s re-election prospects next year and what the landscape would look like with a Democratic sweep, especially seeing how far left the party has turned. I have no doubt that we will see an attempt at fiscal reflation through Modern Monetary Theory, higher top marginal rates of taxation on the upper class, dividends, capital gains and a rollback of the corporate tax relief measures.
Inflation hedges, once again, gold, silver, TIPS and even real estate, will be in vogue. But, such a political swing will be anathema to the equity market, which may yet endure a 1966-82 secular bear phase. Let me assure you that the majority of the folks running for the top job in the Democratic Party are no fans of Mr. Dow and Mrs. Jones.