Small Business Optimism Rebounds Slightly

Small Business Optimism - Another Rally Tuesday

The stock market has almost recovered all the losses from the minor correction last week. On Tuesday, S&P 500 increased 0.3%, Nasdaq increased 0.44%, and Russell 2000 was up 6 basis points.

Just like what happened 3 times last fall, the S&P 500 has had trouble around the 2,800 mark. It is currently 8.48 points away from 2,800.  I usually don’t pay much attention to these round levels. But it’s notable how this area has caused weakness 4 times in the past few months.

S&P 500 is now up 11.36% year to date as it is very close to its 2019 high. CNN fear and greed index oddly fell 1 point to 58 even though stocks were up.

That’s even with the VIX falling 3.91% to 13.77. Best 2 sectors on Tuesday were the utilities and healthcare which increased 0.62% and 0.67%. Utilities did well because treasuries rallied.  

Only 2 sectors were red on Tuesday. Consumer staples fell 2 basis points. Industrials fell 0.91% as Boeing stock fell 6.15%.

It’s interesting how Boeing was in the worst possible shape to deal with this negative catalyst. It was extremely overbought before this plane crash. Its stock was having the best start to the year  for a Dow firm since Microsoft in 2001. It was due for a pullback. It’s very unfortunate how this happened.

The industrials sector won’t outperform like it did in the first 2 months of the year if Boeing continues to underperform.

Small Business Optimism - Yield Curve Flattens

Even though the stock market rallied, the treasury market also rallied. That has been the case for most of the year. Treasuries have rallied partially because inflation has fallen.

That’s great for stocks. However, one must wonder how long this stock market rally can last with bond yields this low. To me it looks like bonds have a better chance of being correct. There is an economic slowdown already underway. To be clear, treasuries being correct doesn’t mean a recession is coming soon.

2 year yield fell 3 basis points to 2.45% possibly because of the disappointing core CPI reading. It is currently at 2.46% which puts it just 6 basis points higher than the Fed funds rate.

The 2.4% level is huge as the 2 year yield falling below it would invert the near term part of the curve. It would signal investors are expecting a rate cut this year. Technically, the 2 year yield fell below 2.4% when it hit 2.38% in early January. But that was a blip which was reversed quickly.

Small Business Optimism - This decline in rates has been a longer more pronounced process, which means it’s more likely to stick.

The last time the Fed gave guidance was in December 2018. Fed stated it would hike rates twice in 2019. Switching from 2 hikes to 1 cut would be a massive change. That’s unlikely. Since the Fed stated it would be patient, I’m expecting no hikes to be forecasted this year.

The 10 year yield fell 4 basis points to 2.6% which means the curve flattened. It is currently at 2.61%, making the difference between the 10 year yield and the 2 year yield 15 basis points.

Cycle low was an 11 basis point difference, which means the curve is relatively close to an inversion. Some economists and investors believe the 11 basis point difference in December was the trough of the cycle. I disagree.

The curve needs to flatten 5 basis points to prove them wrong. That’s not much of a margin for error.

The 2019 low in the 10 year yield that was hit and revoked quickly in early January was 2.55%. It would be remarkable to see the 10 year yield fall below the Fed funds rate.

Fed could do that with one hike, but hikes are probably off the table for the next 12 months. There is a chance the economy recovers after this slowdown, allowing the Fed to resume its hike cycle. In that case, the 10 year yield would be much higher, so a hike wouldn’t necessarily invert the curve.

Small Business Optimism - NFIB Small Business Index

This wasn’t a great NFIB small business optimism report because other sentiment indicators such as the consumer confidence and housing market index rebounded by a larger amount.

The February NFIB index only increased from 101.2 to 101.7 as you can see from the chart below. That missed estimates for 102.5.

Expectations for the economy were bound to improve once the government shutdown ended and stocks rallied. Small business owners aren’t economic experts. They follow simple indicators to help them gauge where the economy is headed.

Just as I expected, the net expectations for the economy to improve increased 5 points to 11%. It was the best reading in this index. That’s where most of the positivity ends.

Since I already expected that reading to improve, there’s not much to like from this report. Earnings trends fell 4 points to -9% and plans to increase employment fell 2 points to 16%. 3 of the indexes in this report were flat.

Small Business Optimism - Markit Business Outlook

Markit business outlook index fell to 29% in February. It measures the net balance of companies that expect to increase output in the next 12 months. That was a 2 year low as the reading fell from 38% in October.

Output index is still way above the prior slowdown’s bottom which was in the mid-single digits. However, there is no indication the slowdown is near its end. This is the 3rd straight decline in this index.

Employment expectations fell to the lowest level since June 2017. That’s consistent with the weak February labor report which showed job creation of just 20,000.

It’s interesting to see that the net balance for research and development spending fell from October 2018 because research and development spending exploded higher in Q4.

Outlook for manufacturing is below that of services which isn’t a surprise because Markit’s February PMI report showed manufacturing was growing much slower than services.

The net balance of firms expecting more profits fell to 26% which was the weakest reading in 2 years. It was still above the world average of 16%.   

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