Your Weekly Update

Did you know that Native American rain dances actually worked 100% of the time? Well, they actually did! How’s that possible? It’s because the natives refused to stop dancing until it started raining.

Today’s native doomsayers—whose prognostications are, in a rough market environment, destined to generate huge numbers of clicks and, thus, inspire the advertiser-customers of the outlets that feature them—are getting lots of love these days from the media.

I’ll refrain from directly picking on any of them today (I’ve done that plenty over the years—here’s the latest, here’s the one before that), and simply suggest that the next time you hear someone claim that he/she is an uncannily accurate seer of the future—and sees the dimmest of times ahead—you google his/her name and add “past predictions”. You’ll either discover that he/she’s been making virtually the same prognostication for years (that’s if he/she’s smart and has solved the mystery behind the success of Native American rain dances), or, he/she’s been flat out wrong the majority of the time. Of course when we’re talking strictly about the perennial doomsayers, it’s both!

That said, there are indeed a few present day pessimists who deserve more than a passing dismissal. They’re the ones who have a history of guessing in either direction and who actually trot out legitimate data that points to a present trend that they feel will continue—and, for the moment, therefore signals that the next recession is virtually upon us. One of the more popular, and legitimate, trends being trotted out of late is the flattening yield curve. Numerous times over the years I’ve heralded the yield curve (the slope of treasury debt yields from short to long-term) as one of the best-ever economic indicators. When the curve inverts—when short-term yields exceed long-term yields—history suggests that we should brace ourselves for the next recession. I track it religiously and, yes, the curve has been flattening of late.

The problem I have with the notion that the present spread between 2 and 10 year treasuries (the “2s/10s spread” as it’s called) virtually assures we’re on the cusp of some serious trouble, is that, as my chart below illustrates, we’ve been right here, or worse, many times over the past few decades without soon entering a bear-market-inducing recession (the red circles are those telltale inversions, the white circles are all the times we’ve been right where we are today, or worse):     click to enlarge

Inverted Yield Curve 2s 10s

With (history as our guide) 2.5 years being the shortest distance between the current (or flatter) yield curve and recession, I don’t think the 2s/10s spread signals any issues just yet.

The following statement from Bespoke Investment Group (their release yesterday inspired me to produce the above chart) speaks to what, along with the non-threatening yield curve, should for now alleviate any great concern over the odds of impending recession:

With total income continuing to grind higher at unspectacular but stable rates it’s hard to see where a demand shock (lower consumer spending, 70% of the economy) could come from. Debt levels are modest and the cost of servicing that debt is at an all-time low; not the stuff recessions are made of.

Given that we just endured the roughest first week in U.S. stock market history, I thought I’d start this weekend’s message with the above look at recession probabilities, as—historically speaking—great bear markets are things of recessions.

So what was last week all about? As I stated right out of the gates (and again here), stocks simply weren’t cheap to start the year (they’re cheaper now). Which, by itself, isn’t a bad thing if interest rates and inflation stay low. Get where I’m going? Yep, the Fed just raised its benchmark rate, and early in the week two voting members said they’re going to keep it up regardless of whether inflation rears its head soon or if the stock market threatens a fit leading up to each FOMC meeting. I’m thinking the balance of the voting members aren’t too keen on those comments right about now.  So then, if interest rates are to rise, stock valuations must come down. Which, in the absence of a belief that corporate earnings are about to rise, means share prices must come down. Within minutes of the release of Friday’s impressive jobs number I received a CNBC news flash that featured the employment report and the Fed in its title. As in, ‘good job growth makes for a more aggressive Fed’.

Plus, there’s China. The now freer floating Yuan (China’s currency) is struggling to stay above water as the economy it represents is showing weakening growth in its once defining sector (manufacturing)—which sparked a massive selloff early in the week that led to the triggering of a newly adopted circuit breaker, which abruptly called a close to two trading sessions. The circuit breaker was wisely abandoned after Thursday’s session, which, along with China’s central bank propping up the Yuan, led to an impressive 2% rally in the Shanghai Index on Friday. And while a stabler China did spark a 200 point jump in Dow futures overnight, it wasn’t enough to avert yet another shellacking during the U.S. trading session to end the week.

Plus, while I continue to resist the popular notion that low oil prices are an inherently bad thing for the market, or the economy, Friday’s action in stocks clearly followed oil’s intraday moves. And, true correlation or not, they both got creamed for the week.

Plus, and lastly, I think traders are nervous about the coming earnings season.

Bottom line for the moment:

Fundamentally-speaking, stocks just got cheaper and, thus, more attractive.

Technically-speaking, the charts show a market that’s substantially “over sold”, which would suggest a near-term bounce is in store. There was, however, some real technical damage done this week (smashing through prior support levels), that—if there’s no firm bounce and reaffirmation of previous support sometime soon—heightens the possibility of a re-testing of last August’s lows.

Now, should the latter inspire a YIKES! or a YES!? Well, like I keep saying, last year’s correction was in my view a non-event. Thus, while nobody likes to see their share values decline*, since such declines are ultimately inevitable and would likely set the spring for an ultimate move to higher highs, I’ll be trying my best to convince you it’s a YES!—if we get there. Particularly if there’s no recession on the near-term horizon…

*Watch the whiteboard lesson at the bottom of  Thursday’s blog post to put declining values into perspective…

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