Stocks End The Week On A Positive Note
The S&P 500 was up 1.44% on Friday, but it still closed down 1.03% for the week. The chart below shows the volatile action and the reversals throughout the week. The 2.93% decline on Wednesday sunk stocks for the week. The S&P 500 is down 4.53% from its record close; it is still up 15.23% year to date. The media and some investors have overhyped this correction which has so far been relatively small.
The yield curve inversion caused recession fears to trend on Twitter. As people who don’t follow markets will find out, predicting a recession isn’t that easy. The only way the yield curve definitely means a recession is coming is if it causes consumers to be so fearful that they start saving more and spending less. I don’t see that happening. If a family needs a new washing machine, they won’t delay purchasing one because of the yield curve. The tariffs could prevent these types of purchases, but that’s another topic entirely.
Details Of Friday’s Action
The Nasdaq increased 1.67% and the Russell 2000 increased a fantastic 2.19%. The small cap banks had an amazing day; the KBW regional bank ETF rallied 2.8% because the yield curve steepened and yields on the long end increased. As I will discuss later in this article, it would be problematic if the yield curve steepened sharply. The VIX was down 12.8% to 18.47. I think it will fall further because the extreme fear in the market is overdone.
The latest data suggests there is little reason to worry about a recession in Q3 as the back to school shopping season seems to be going well. Wal-Mart just had a solid quarter and the retail sales report was great. Even though last year, I expected the 2019 holiday shopping to be weak, I have since changed my mind. I expect it to be ok since real wage growth has been good.
The CNN fear and greed index only rose 1 point to 20 which still signals extreme greed. It stayed in extreme greed even though the volatility category improved from fear to neutral. For the 4thday of the week, every single sector went in the same direction. There were 2 down days of that nature. Friday was the 2nd up day.
The gains were broad based as no sector rallied more than 2%. The best 2 sectors were the financials and the industrials which rallied 1.86% and 1.9%. The industrials gained back their losses from Thursday when the weak industrial production report came out. It’s as if that report was never released. To be fair, the sector had been down in the days preceding that report. It should surprise few investors and economists that the manufacturing sector is contracting.
More Rate Cuts Coming As Powell Is Set To Speak
I think in the near term the long bond and gold are done rallying because the run has gone too far versus the economic fundamentals. On Friday, gold was up 7 basis points. It’s up 6.06% in the past 30 days and 28.56% in the past year. It’s notable that gold usually does well in September because of the Indian wedding season and the volatility in the stock market. Just because stocks usually do poorly in September doesn’t mean that will occur this coming month. The summer correction already happened.
As I mentioned, the long bond sold off slightly and the yield curve steepened on Friday. The yield curve steepens sharply during recessions, but don’t get scared just yet as the curve steepens in full percentage points not basis points. On Friday the 10 year yield rose 3 basis points to 1.55%, the 2 year yield fell 2 basis points to 1.48%, and the 30 year yield was up 6 basis points to 2.03%. The difference between the 10 and 2 year yield is up to 7 basis points. It looks more likely that the yield curve inversion happened, and the steepening cycle is starting. We might not get an inverted close, but I don’t think that matters. Few are discussing this.
The 2 year yield is 2 basis points away from its 52 week low. That means the odds of rate cuts are relatively high. There is now a 21.2% chance of a 50 basis point rate cut in September. If stocks rally in the next few weeks like I expect, there’s a low chance the odds of a double cut increase. The odds of there being 3 more cuts this year have increased in the past week. On August 9th, there was a 41.2% chance of at least 3 more cuts and now there is a 58.5% chance. Powell’s speech next Friday at Jackson Hole will have a big impact on all markets. With not much economic news coming out next week, it’s the most important event of the week by far.
Leading Index Falls Slightly
With the yield curve predicting a recession by the end of 2020, the ECRI leading index is extremely important because it’s one of the few indicators which can see close to that far out. In the week of August 9th, the ECRI index fell 1.6 points to 144. The yearly growth rate only fell from 0% to -0.5%, as you can see in the chart below. It didn’t fall much because of the increasingly easy comps. It’s not surprising to see this index fall since stocks fell. It might fall further next week. The good news is it’s not predicting close to the weakness that it did in the beginning of the year. We are now going through the weakness the index predicted 8 months ago.
Conclusion
The stock market ended this volatile week on a positive note. The long bond finally took a break from its relentless rally. It’s pretty clear the Fed will cut rates in September and the consumer is in ok shape (although the consumer sentiment report even calls that into question). The political issues such as the Hong Kong protests and the trade war are the wild cards that could cause this correction to worsen and last longer.
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