Manic Depression – Bipolar Markets

Jimi_Manic_DepressionManic Depression is touching my soul
I know what I want but I just don’t know… Jimi Hendrix
By David Nelson, CFA, CMT
On the heels of the most dovish FOMC press conference in recent memory investors seem to be suffering from “manic depression” or some other severe bipolar disorder. In the 15 hours following last Wednesday’s rate decision the scoreboard flipped from bear to bull and back again. Investors stumbled into the locker room dazed and confused ending a week that gave us more questions than answers.

The 2 hours of trading post the Fed decision saw stocks ending slightly in the red, but any lingering fear disappeared Thursday as investors bid shares of their favorite names higher throughout the session. Whether it was buyer’s remorse or the sudden realization that the Fed is standing pat for a reason, Friday saw traders cutting exposure with one eye on stocks and the other on bonds.

S&P 500 – Bipolar 5 days
Manic Depression

The breakout of the iShares 20 Year ETF (TLT) and the long end of the yield curve hitting one-year lows sent a shiver through trading desks. The short end of the curve has been inverted for some time but last week the inversion moved all the way out to 10 yeas leaving only the long end above water.

Almost by definition an inverted curve is telling you the Fed is going to lower rates and that’s re-enforced by probability charts or analysis like FactSet’s Policy track. Today, the probability of a cut has jumped to 24% by July and near 40% by the end of the year.

TLT 1 Year Chart
tlt gap

So just how much trouble are we in? Is the United States doomed toward recession or are we still the best house on the block and it’s the weak global outlook holding us down? The most important part of last week’s FOMC outlook was a realization we don’t live in a vacuum. Pointing to slowing global growth as part of the catalyst to remain “patient”, the Fed confirmed they are watching both China and Europe.

Curve inversion where short rates are higher than long-term rates always brings out bears who correctly point out that while not perfect, yield inversion can often be an indicator a recession lies ahead. Of course, just how far off is a question not easily answered especially given the fact that the sample size isn’t all that large. We’ve only had 5 recessions since 1975 and just 10 since World War II. That works out to less than one a decade. Given we’re 10 years post the financial crisis prognosticators are tripping over themselves to predict the next recession and Armageddon that follows. Unfortunately, even when correct the event may be years out or in some cases not at all. If used as market timing tool I suspect without doing the math the results aren’t all that impressive

Yield Curve Inverts

Never the less we should take note and if nothing else take inventory of both assets and liabilities. Here we are a couple of months past the Christmas Eve low and a 180 degree turn by the Fed first in rhetoric and now stated policy, I think it’s safe to say some of the FOMC decisions last year were a policy mistake. Today, the same Fed that was on Autopilot determined to hike rates at least 3x in 2019 is now patiently waiting until they see the whites of the eyes of inflation.

10year – 2year yields

In addition, we’ve been informed that the roll off in the current $4 Trillion balance sheet will start to slow in May and end by September. Here is where Mr. Powell and I part company. Clearly $50 Billion per month was too much but given a debt level this large, surely markets could handle something smaller even if it takes more than a decade. What event or level of economic activity are we looking for to correct what is clearly not in the long-term best interests of economic or monetary policy.

Financials vs Market
xlf vs mkt

Meanwhile the reversal has some definite implications for both individual stocks and sectors. It didn’t take long for traders to abandon banks concerned net interest margins will be under pressure. The added concern given the slowdown in global growth has pressured both money center and regional banks. Pessimism is high for the sector but before you completely abandon financials keep in mind valuations are closing in on a 35% discount to the broad market. JPMorgan (JPM) breaking under 100 Friday trades at just 10x 2019 earnings.

On its own, valuation can’t get you there. My calls for banks to outperform early in 2018 lasted only a short time. The relative performance chart above shows financials diverging negatively from the broad market as far back as June last year. If you don’t like the banks look at some of the asset managers like BlackRock* (BLK). They are paid for assets under management and last time I looked even with the end of week sell off stocks are close to 20% above the lows. By definition estimates should move higher.


Utilities all time
Some of the winners are obvious i.e. strong dividend payers like Real Estate and Utilities. Of course, a lot of that good news is reflected in these shares both recently breaking to all-time highs. With some shares like Con Edison (ED) and Southern Company (SO) trading near 20x forward earnings, valuations already reflect the changing fortunes.

Consumer Discretionary stocks seem to march to their own drummer and often driven by company specifics. How often have we seen one retailer bang it out of the park while another victim of Amazon (AMZN) stumbles and falls. I suspect Industrials and Technology will follow the latest in trade and GDP while Consumer Staples are lifted each time the R word makes the rounds.

spx breakout breakdown

While we broke through some key resistance levels in the S&P 500 and threaten an all-time high all the usual suspects are still with us. China, Europe, Brexit not to mention a completely dysfunctional Washington that is likely to accomplish nothing as responsible legislation designed to help Americans, gives way to partisan posturing and rhetoric focused only on winning an election.

Never the less none of the above keeps U.S. markets from opening every day promptly at 9:30AM EST. We’ll continue to take it one stock and one day at a time.

Almost nothing in the way of earnings next week. With the quarter just about to close focus starts to shift to Q1 reports and the pre-announcement season ahead. CEO’s lowered the bar during last quarter’s conference calls cutting both top and bottom-line estimates. Did they lower the bar enough? We’re about to find out.

…Manic Depression is a frustrated mess… Jimi Hendrix

*At the time of this article some funds managed by David Nelson were long BLK