Small Banks Rally 3.53%

Small Caps Outperform Large Caps

At first glance it seems like Monday’s trading session was boring because the S&P 500 fell 1 basis point and there weren’t any major economic reports, nor were there tweets from Trump on the trade war. However, there was some interesting movement below the surface. Nasdaq fell 0.19% and the Russell 2000 rose 1.27%. Small caps had a great day. Last time the S&P 500 fell and the Russell 2000 was up more than 1.25% was November 2016 which was the month of the presidential election. That’s interesting because last week there was a day where the 10 year yield rose the most since November 2016.

Russell 1000 value index outperformed the Russell 1000 growth index by the most since June 3rd and the 3rd most since May 2009. June 3rd was the bottom for the S&P 500 in this spring’s correction. As you can see from the chart below, on Monday the worst stocks did well and the best stocks sold off. The bottom 20% of stocks in terms of year to date performance rose 3.5%. The top 20% sold off 1.4%. This all leads us to the driver of this performance which was the rally in the small bank stocks. The KBW regional bank ETF rose 3.53%. The XLF S&P 500 financial ETF rose 1.54% as it was the 2nd best sector on the day. The financials rose because treasuries sold off sharply as I will describe in the next section.   

Politics Drives Sector Performance

The best sector was energy which rose 1.85%. The sector increased because WTI oil rose 2.4% to $57.85. Oil rose because Prince Abdulaziz confirmed he will stay with Saudi Arabia’s policy of limiting oil production to support prices. Oil prices have been stable this year despite the global slowdown. Year to date oil has outperformed most commodities significantly. Oil is up 26.72% year to date; the CRB Bloomberg commodity ETF is up 2.66% in that period. Therefore, this policy has worked. The worst sectors on Monday were healthcare and real estate which fell 0.92% and 0.87%.

There was a slew of early state polls released on Monday, most of which were bad for Biden and good for either Sanders or Warren. Firstly, a CBS poll showed Biden up 3 points on Sanders in Iowa. He was up by 5 in the last CBS poll. In the CBS New Hampshire poll, Warren was up by 1 on Biden. Compared to the last CBS poll, Biden fell 1 point, Sanders rose 5 points, and Warren rose 9 points. Sanders was up by 2 in Nevada which is bad for Biden who was up by 10 in the last poll by Gravis. The Massachusetts and South Carolina polls were better for Biden as he was up by 2% and 25% over Warren and Sanders respectively. On Thursday, the debate will have the top 10 candidates in one night. It will pit Sanders and Warren versus Biden for the first time.

Big Selloff In Treasuries

There weren’t any major economic reports on Monday, but treasuries still sold off very sharply. This could have been because of the solid wage growth in the August BLS report or because the long treasuries trade has been way overdone. Specifically, the 10 year yield rose 8 basis points to 1.64% which is 21 basis points above its recent low. Maybe the 10 year yield won’t fall to a new record low this year.

As you can see from the chart below, the 10 year yield is highly correlated with the ISM manufacturing PMI. The 10 year yield hasn’t been falling because international buyers are flocking to treasuries. If the correlation between the PMI and the 10 year yield continues, I can see the 10 year yield falling further, but then bottoming later this year because I think the PMI is near its bottom. Maybe this selloff in the 10 year is telling us traders see the manufacturing sector rebounding soon.

The 2 year yield rose 6 basis points to 1.59% which is 15 basis points above its recent low. This means the 10 year yield is 5 basis points higher. The curve is barely normal. As I have been saying, steepening means a recession, but the current amount isn’t close to enough to signal a recession just yet. Further normalization was seen in the long end of the curve as the 30 year yield increased 10 basis points to 2.13%. It’s up 23 basis points from its recent low.

Fed To Cut Rates In 8 Days

The Fed’s rate decision is next week. There is a 93.5% chance it will cut rates. The likelihood of fewer rate cuts increased with the rise in the 2 year yield as now there is a 48.1% chance the Fed cuts rates 2 more times this year. Powell spoke on Friday. He stated, “I think it is the case that uncertainty around trade policy is causing some companies to hold back now on investment. We’ve been hearing quite a bit about uncertainty. So for businesses, to particularly make longer-term investments in plants or equipment or software, they want some certainty that the demand will be there.”

He makes a good point. Uncertainty is terrible for making long term plans. I don’t know if 3 rate cuts this year will bring back certainty. I think if there’s a trade deal this fall, there will be a burst in economic activity. The Fed doesn’t control this. It simply reacts to economic reports and changes to expectations.  


By seeing an end to this huge rally in treasuries, I’m not saying yields will rise enough to make investors question valuation models or hurt the housing market because mortgage rates are much higher. It’s just tough to see an overcrowded trade stay that way for months on end continuing to break records without any reversals. The 2 most important reports this week are CPI and retail sales. I will be keying in on control group sales because this category’s growth has been unbelievable in the past 2 months. Can it continue with the tariffs hurting sentiment? We will find out on Friday. 

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