Financial Review by Sinclair Noe
DOW + 236 = 18,000
SPX + 25 = 2105
NAS + 62 = 5076
10 YR YLD + .06 = 2.48%
OIL + 1.29 = 61.43
GOLD + 9.20 = 1186.60
SILV + .07 = 16.11
The yield on 10-year German government bunds broke above 1% overnight for the first time since September 2014; part of a broader global bond sell-off that’s been deepening since late April. Last week, ECB President Mario Draghi said investors should get used to periods of higher bond market volatility and stated the central bank wouldn’t do anything about it. US government bonds are selling off – which is sending yields higher as they move inversely to price – as part of the global bond rout that was started back in April. The size of the US corporate-bond market has ballooned by $3.7 trillion during the past decade, further siphoning demand from US Treasuries. And some of that money is just getting out of bonds, which might explain the rotation into stocks today.
Of course, I have no idea why the stock market moved higher today. I don’t know, you don’t know, and the talking heads on TV don’t know. It is nearly impossible to know what might spur or spook the herd of millions of investors to suddenly move in any given direction at any given time. Is it a new trend or just a bounce on pent-up demand? We don’t know. What we do know is that markets fluctuate, and they also rotate.
And while US equity markets have been trading in a tight range, there’s still plenty of action under the surface. A closer look at the 10 main sectors in the S&P 500 index reveals that investors have continued to move out of one sector into another, rotating in an anticipation of an interest-rate hike this year and subsequent rise in borrowing costs. The process of dumping interest-rate sensitive stocks such as utilities and consumer staples have accelerated over the past few weeks thanks to gyrations in government bond markets. The utilities sector is already in correction territory, having dropped more than 10% from its late-January peak, and down 4.6% since the start of the month.
Internal rotation isn’t the only problem with the current market. Deterioration in market breadth – markets rising on the back of fewer and fewer stocks – is something a lot of investors are watching. Less than 60% of S&P 500 components are trading above their 200-day moving average. Trading above the average implies an upward trend while trading below it implies that the stock may be losing support and is likely to fall further. Today, the 10 main sectors in the S&P 500 were all higher. Yesterday, the Dow Industrial Average went negative year to date, bouncing back into positive territory today with all 30 Dow stocks posting gains. Pfizer, Apple, United Health, and Disney have posted double digit returns this year. Wal-Mart, Intel, and American Express have posted double digit losses for the year.
Anyway, the selloff in bonds has pushed people into real estate. While that may seem counter-intuitive, there’s a reason: fear that rates will move even higher. Total mortgage application volume jumped 8.4 percent last week. Refinance volume increased 7 percent on the week, and applications to purchase a home jumped 10 percent, both seasonally adjusted. Purchase volume is now 15 percent higher than the same week one year ago.
The selloff in bonds gets people all worked up, even though it has not been particularly dramatic. There was more volatility in the bond market in 2013 with the “taper tantrum”; you may remember a brief spell where just the hint of exiting QE saw the 10 year note spike above 3%. Still, the yield on the 10-year Treasury note has climbed from 1.65% in January to 2.49% today as the markets anticipate the Fed raising the Fed funds target rate; but if or when the Fed hikes rates, it will likely be small, incremental, well-communicated increases; and it might not be anytime soon. Today, the World Bank joined the IMF in asking the Fed to wait until 2016 before it raises rates, citing an uneven US recovery and the risks to emerging markets of tightening policy any sooner.
I read today that higher yields were a sell signal. No. The sell signal was when the yield on the 10-year bund dropped to 0.05% back in April, or when US Treasuries were floating around 1.65%. There is certainly a chance that yields could breakout, and prices could breakdown when yields hit 2.5%, and if that results in redemptions at bond funds and bond ETFs, we could see a domino effect, or what trader’s call “spontaneous combustion” that could push yields much higher with added volatility. But that’s the exception, not the norm. Usually, the bond market has a built-in self- correcting mechanism. A deep selloff will have economic consequences. Rates typically rise when the economy is improving; higher rates tend to cool economic growth before it can get overheated, and as the economy slows, rates drift lower. Of course markets can and do overshoot.
And all this speculation is based on the assumption that there is a certain efficiency and the markets are not rigged. You know what they say about assumptions. The Justice Department has begun an examination of trading in the US Treasury market. The government is also continuing to look into possible collusion in gold and silver markets and in trading around certain oil benchmarks. The investigation into Treasury trading is in the very early stages, but this follows guilty pleas from some of the biggest banks on charges of rigging the Forex markets, and the Libor markets, and the ISDA Fix; which means banks are in no position to be anything other than cooperative with investigators.
I also read today that the stock market rallied on positive news regarding Greece. German Chancellor Angela Merkel’s government may be satisfied with Greece committing to at least one economic reform sought by creditors to open the door to bailout funds. While the Germans still insist on a package of steps that includes higher taxes, state asset sales and less generous retirement benefits, they may settle for a clear commitment by the Greek government to a measure up front to unlock aid. Merkel sounded a positive tone, saying: “Where there’s a will, there’s a way. The goal is to keep Greece in the euro area.” Of course, we’ve heard many times that we are nearing a settlement on the Greek problem, usually followed by Teutonic demands for discipline and austerity. I’ve been saying that the only intelligent solution involves giving some sort of break to the Greeks. It might happen, but don’t hold your breath. And I doubt the hint of resolution will lift global markets, even though a breakdown in negotiations could cause serious damage.
Index provider MSCI will not add Chinese A-shares to its widely tracked emerging markets index. The Shanghai Composite ended almost flat after falling as much as 2.2%. MSCI said it aims to add the yuan-denominated equities at “some point”, just not today.
Spending on health care in the US fell at a 0.4% annual rate in the first quarter, suggesting gross domestic product will be revised even lower. Health care is the second biggest service sector by spending after finance. The U.S. economy contracted by 0.7% in the first three months of the year, but the government will revise the data for a second time at the end of the month. And even though spending was down in the first quarter, over the past year health-care spending has risen at an unadjusted 7.2% pace.
Workers’ wages and benefits may be picking up faster than previously thought. The Labor Department reports employer costs for employee compensation jumped 4.9% from a year earlier in March, the second consecutive increase at that relatively robust level. Average cost per hour worked rose to $33.49 in March, versus $31.93 a year earlier. Wages and salaries climbed 4.2% to $22.88 while benefits rose 6.4% to $10.61. Health insurance, one component of benefits, was up 2.5%. That’s well above a 1.2% gain as recently as the third quarter of 2013 and a sign the labor market is getting tighter.
US crude oil inventories continue to fall. The latest data from the Energy Information Administration showed that inventories fell by 6.81 million barrels in the week ending June 5. Last week’s decline brought the total to 470.6 million barrels, keeping inventories at the highest levels for this time of year in at least 80 years.
The US is now the top oil and gas producer in the world. US oil production rose to a record last year, gaining 1.6 million barrels a day, according to BP’s Statistical Review of World Energy. The US now passes Russia in total oil and gas production; and the US has passed Saudi Arabia as the top crude producer. The BP report also shows China’s energy demand growing at the slowest pace since the Asian financial crisis of the late 1990s, as the economy slows. And while there has been a boom in US oil production, we’ve seen an even bigger boom in non-fossil fuels and renewables. Last year non-fossil fuels, including nuclear, accounted for more of the increase in global energy consumption than oil, gas and coal combined. Particularly notable are record installations of solar panels.
The EIA released its latest short-term monthly outlook report on Monday, which forecasts that US crude production will fall from 9.6 million barrels per day in May until early 2016. Meanwhile, US oil production is on the rise for now. And at the same time, we are seeing demand destruction. Just this week, we saw the G7 agree to cut carbon emissions a record amount in the next three-and-a-half decades and end fossil fuel use altogether this century. In the past few years, we have already seen an extended flat period in oil demand, due to the financial crisis, that has only recently shown modest gains as prices dipped. The age of oil has now begun to end; that may seem like an exaggeration and it doesn’t mean the age of oil is dead today; it will take time and at the very least it means more volatility, so be aware and beware, because the world is changing in a massive way.