US equities closed the week with a rousing Friday rally, but that’s no solace to everyone who was whipsawed by tariff headlines, data disappointments abroad and the inversion of the 2s10s curve on Wednesday, a development that sent the Dow careening to its worst one-day loss of 2019.
1% moves in either direction are now the norm, not the exception. The US data continues to come in solid, but that only muddies the waters. The stronger the domestic economy, the more concerned markets get about the Fed sticking to its characterization of the July cut as a “mid-cycle adjustment”. That characterization has convinced traders that policymakers are behind the curve (figuratively and literally) which, in turn, is putting risk assets behind the eight ball.
Donald Trump’s never-ending trade war and the conflicting headlines it’s creating have become the stuff of nightmares, especially to the extent they spawn unpredictable policy decisions in Beijing.
Despite Friday’s rally, US equities fell a third week, the worst streak since May, when the S&P dropped more than 6% following Trump’s decision to break the Buenos Aires truce with Xi.
Meanwhile, bonds surged, as 10-year yields in the US breached 1.50% and 30-year yields fell below 2% for the first time. As we noted on Thursday, the “everything rally” is rapidly metamorphosing into one of the most spectacular safe-haven bids in recent memory, with Treasurys, the yen and gold all outperforming. This was the third straight week that stocks have fallen while Treasurys rose sharply, reminiscent of the May rout.
All in all, it was the sixteenth consecutive week that the S&P ETF and the largest exchange-traded Treasury bond vehicle moved in opposite directions. To find a similar streak, you have to go all the way back to 2012.
Clearly, stocks have now gotten the message from bonds, and that message is not a good one about the prospects for the US economy, despite resiliency in the data.
“Growing investor concerns drove a surge in volatility this week [as] the VIX reached 23 and S&P 500 has moved by more than 1% during 3 of the past 4 trading days”, Goldman wrote on Friday evening, adding that “a combination of trade uncertainty, weak economic data in China and Germany, and a brief US Treasury yield curve inversion raised investor fears of a global economic recession”.
The good news is that Q2 earnings were better than expected and, assuming a moderate acceleration in profit growth from here, stocks should be ok.
As far as the signal from the curve goes, Goldman notes that “historically, the 10y-2y curve inversion has preceded US recessions but has not been a negative signal for equity investors”.
In fact, after the last five inversions, it took the economy an average of 22 months to see a downturn, and the S&P 500 posted an average subsequent 12-month total return of +12%.
Here’s hoping this is a case where past performance is indicative of future results.