Stocks Decline, Ending A Wild Week
Friday was emblematic of the week’s action as there were a couple big swings. The market opened lower and continued falling until about noon. The S&P 500 was down about 1.25% at the low of the day. From that low to 3:40 PM, the S&P 500 increased about 1%. Finally, in the last 20 minutes, it fell 0.47%. It closed down 0.66%. The Nasdaq fell 1% and the Russell 2000 fell 1.25%. The VIX increased 6.27% to 17.97. It has plenty of room to move higher next week if the trade war gets even worse.
The CNN fear and greed index stayed at 25 for a 3rd day. It’s still at extreme greed. That’s a positive near term signal for stocks. However, negative headlines can still move stocks lower. The chart below shows the NDR trading sentiment composite. Unlike the AAII survey, this one shows bearishness is only the lowest since early June. It’s not close to as low as December which makes sense because the S&P 500 only fell 6.8% this time versus the 20% it fell in December. That’s not to say this isn’t a bullish signal. The reading is at 35.56. Anything below the low 40s signals excessive pessimism which is bullish. However, there is room for sentiment to get worse and for stocks to fall further. That would be an even better buying opportunity like in early June and late December.
Review Of Friday’s Action
Most sectors fell except healthcare, utilities, and real estate which were up 0.18%, 0.04%, and 0.07%. The biggest losers were energy and technology which both fell 1.25%. Uber was one of the biggest losers as it fell 6.82%. The firm lost $5.2 billion in what its CEO called a once in a lifetime hit. Generally, you want to avoid once in a lifetime hits, but this extreme language shows he is confident better results are coming. However, investors don’t believe him as the stock is below its first close on May 10th. At $40.05, it is just $3.97 from its all-time low. I see no reason why the market won’t push it lower soon.
It’s embarrassing that the CEO claims they need to do a better job telling their story to investors. It’s not a storytelling issue; they need to stop losing so much money and missing estimates. Uber lost $4.72 per share which missed estimates for a loss of $3.12; it’s revenues were $3.17 billion instead of $3.36 billion. Uber’s losses were bigger than total full year 2018 losses for all but 3 S&P 500 firms. The firm isn’t going exist by the time self-driving cars become popular if it keeps losing money at this pace. Self-driving cars would help margins.
Treasury Market Update
Even though stocks fell on Friday, treasury yields rose as the 10 year yield and 2 year yield were both up 3 basis points to 1.74% and 1.65%. Their difference is just 9 basis points. Their can easily be an inversion next week especially if the Fed suggests it will only cut rates one more time this year. There is now just a 14.2% chance the Fed cuts rates twice in September. The decline in those odds explain why the curve flattened.
Besides the past couple days, there has been intense buying in the treasury market recently. Investors panicked into treasuries. The chart below contextualizes how overbought the 10 year bond became. Bank of America’s fair value model based on the economic fundamentals pegs the 10 year yield at 2.5%. It closed on Friday at just 1.74%. It is 2 standard deviations too rich. Whenever an asset moves into that range, I get interested in fading the trade. Obviously, Bank of America’s model probably isn’t perfect, but it’s very clear that either nominal growth will fall sharply in the next 2 quarters or the 10 year yield will spike significantly in the coming months. The market is pricing in a 2011 type event. If the 10 year yield drops any further, it could be similar to its action during the financial crisis.
Latest On The Trade War
The trade war situation got worse on Friday. President Trump stated, “China wants to do something, but I’m not doing anything yet. Twenty-five years of abuse. I’m not ready so fast.” Every statement Trump makes is part of the negotiation process. The previous story put out by the White House in May was that America wanted to negotiate, but China backed out. One interesting theory I heard is that China will push hard against America during election season (2020) to hurt Trump’s chances of winning. I don’t know if that will happen, but it’s obvious Trump wants a deal by early next year so he can campaign on a victory.
As you can see from the chart below, the CPI across 12 tariff impacted categories is up about 3% in the past 18 months which is much higher than the 1% decline in other core goods. As I have discussed throughout the year, tariffs aren’t going to spike overall inflation higher because demand is weakening. The trade war still hurts the economy because of the uncertainty it gives businesses. Just because tariffs aren’t spiking inflation, doesn’t mean this situation is good for the economy.
Conclusion
This was a very dramatic week for stocks because of the trade war news. The news flow won’t die down in the coming week because there will be a lot of economic data coming out such as retail sales and industrial production. Q2 earnings season is just about over. It was unspectacular, but there wasn’t an earnings recession like some feared. There shouldn’t be any major monetary policy news next week because Fed members aren’t scheduled to speak. The next important date for Fed policy will be the Jackson Hole Symposium which is from August 22nd to the 24th. It will be Powell’s chance to tell us how he sees policy in 2020. It will be interesting to see how willing he is to suggest that this is the start of another rate cut cycle like the market expects.
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