As the markets moved into September there was a lot of fear. As measured by GDP, purchasing managers, and the Institute for Supply Management (ISM), the economy appeared to be slowing. Bond yields were falling as investors believed that the trade war with China was pushing us toward a global recession, as there was talk that ultimately the U.S. would follow Europe and Japan into negative interest rate territory. Beyond that, the collapse of the new issue market (following the failed IPO of We Work and the languishing stock prices of recent IPOs such as Uber, Slack, and Cloudflare) and the sharp sell-off of the formerly hot cannabis stocks made it feel like the speculative energy of this bull market advance had been spent. There just didn’t seem to be the excess cash or the confidence to drive stocks to new highs.
There was just one problem with the “this is it” scenario – as a whole, investors weren’t positioned right. They were too defensive. They had been, in aggregate, selling stocks to buy bonds for more than a year. Stocks just don’t make a major high when investor portfolios are chock full of utility, real estate, and consumer staples stocks. Meaningful market highs happen when the economy is doing well, economically sensitive stocks are in the lead, and investors get ahead of themselves trying to maximize returns.
September became significant, therefore, for what didn’t happen. The rest of the technology sector was not pulled down by the collapsing IPOs. In fact, semiconductor indices moved up to new highs. The trade war did not drag the economy down; September economic data did not show a discernable economy-wide effect. Lay-offs related to plant closures remained isolated events. Rhetoric between the U.S. and China was decidedly less confrontational.
Investors began to take notice. After the September employment report was released on October 4th showing decent hiring strength, stock prices began moving up steadily and bond prices began falling. That type of asset rotation generally indicates a higher risk appetite from investors and implies higher equity prices are expected. Perhaps even more surprising, international stocks began to rally. Foreign markets are, as a whole, more sensitive to a global trade war. Both the U.S. and China can generate sufficient growth internally while most other countries are more dependent on exports. As tensions cooled, cross border orders picked up. Emerging markets are doing well because their economies are generally stronger than foreign developed markets (like Germany or Australia). The former have the latitude to cut interest rates while the latter do not – there rates are already near or below zero.
I believe that before the bull market takes a significant fall (keeping in mind that stocks can decline 5%-10% anytime for any/no reason), speculative activity has to pick up considerably. The excesses related to IPOs and cannabis stocks just weren’t enough; the average investor did not have much exposure there so they did not lose enough to affect their spending and investing decisions.
The Bond Market
The story in the bond market in 2019 has been falling interest rates. Most notably, falling long term interest rates, such that the 2-10 year Treasury spread actually inverted in late August. Two Federal Reserve rate cuts later, that story has been completely reversed. The 2-10 spread was 21 basis points on New Year’s Day 2019. As mentioned, it fell to -4 basis points on August 27th. As of the market close on 11/7/19 it was 24 basis points. The bond market is screaming that the late October rate cut was a big mistake. The stimulus provided by the cut has led to losses in longer-term bonds yet it has not weakened the dollar as many had hoped. Ultimately, the sharp underperformance of high quality, long duration assets will drive investors to shorter maturities and lower quality credits, which is almost always one of the pre-conditions to a more significant market top. When everybody has “ballast”, market declines tend to be minimal.
One of the strongest diversified ETFs recently and year-to-date has been MOAT, the Van Eck Vectors Wide Moat ETF, which follows Morningstar’s patented Wide Moat Focus Index. One of the things I like about it, besides performance, is that it has very little overlap with the major large cap indices in terms of top holdings.
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