Stocks forged higher yesterday as yields took a break from their climb, clearing a path for growth stocks to lead shares higher. Crude oil prices eased, calming inflation fears briefly and Bitcoin turned positive for the year.
Seesaw. I don’t mean to bring back any bad playground memories, only nostalgic ones. Remember those seesaws on the playground? You would sit on one side of a splintery plank of wood (that is another story altogether) and hopefully, a friend would sit at the other end. If everything went as planned, you would have hours of fun, rocking one way and back another as physics…the natural order in the universe… provided the basis for the amusement. All good right? Now there was always a trickster or two on the playground. One of their favorite pranks was to leave you stranded in the “up” position. Helpless, you would watch in fear as the prankster would slip off the back. Without any counterweight to support your weight, you would plunge to the ground only to hear the perpetrator giggle.
The economy very much works like a seesaw. Under normal circumstances, output swings in one direction then back in the other. In this case, it is not physics which provide the power but rather, consumption. Consumers buy and buy pushing prices higher, goods get too expensive, and consumers pull back. More buying means economic growth and pulling back means contraction. I know that I have overly simplified the process, but that is essentially how the natural order of economics works.
In the past few weeks, I have written quite a bit about the shape of the yield curve. Before that, you would have to look back to 2019 for the last time I perseverated on the topic. Back then, a long-in-the-tooth expansion appeared to be on the verge of ceding control to a recession. The yield curve had been flattening for years and ultimately inverted in the late summer of 2019. The part of the yield curve I am referring to is the spread between 2-year Treasury notes and 10-year Treasury notes. When that is negative, it means that you receive less yield for a 10-year loan than a 2-year loan. Remember that when you buy a Treasury Note, you are technically lending money to the Government. Not knowing what the conditions will be like in 10-years, one would expect to get some sort of greater return for taking a longer-term risk. The technical expression for that is term premium. So, when the curve inverts, bond traders expect that economic conditions will weaken in the future and that inflation will be low. Tight current conditions along with higher current inflation keep shorter term yields higher. All of this means that the markets are expecting tight monetary policy to cause future economic weakness. That is also why a curve inversion is almost always viewed as a harbinger of an oncoming recession.
Of course, this time is different. We had a brief recession in 2020 resulting from the pandemic lockdowns. The monetary and fiscal stimulus that followed was unlike any other in history. The stimulus turned the failing economy around and set it back on a growth path. The cost of that unprecedented turnaround was inflation. Skyrocketing demand for goods combined with gummed up supply chains is THE classic cause of inflation and that is where we are at today. Now, we are experiencing inflation not seen in 40 years and the war in Ukraine is causing energy and commodity prices to spike, confounding inflationary forces. The Fed now finds itself in a position where it must act with verve in order to keep the economy from melting down. Yes, the Fed is raising lending rates and it expects to do so often throughout this year and next. There is just one big problem. The yield curve has not been this flat since just before it inverted in 2019! In fact, the yield curve has never been this flat as the Fed embarked on a raising cycle. Last time the Fed began to raise rates after an easing cycle was in 2015. At that time, the spread between 2-year and 10-year notes was around +145 basis points. This morning that spread is at just +7 basis points. That means you would only get 7/100th of a percent more for lending your money for an additional 8 years.
If this seesaw were operating under normal circumstances, the natural order would simply right itself. The Fed may decide to leave rates at its current 0.25% for a while, though it is unlikely given recent comments and projections. Bond traders may reverse course and start selling 10-year notes aggressively and push 10-year tenor yields higher. That may occur but given the circumstances of continued supply chain problems which have now spilled into raw materials, it appears that inflation will continue to eat away at demand and consumption. The Fed has made it quite clear that it is now willing to sacrifice economic growth by fighting inflation with higher lending rates. So, while 10-year yields still have room to rise, increasing anxiety of bond traders could limit upside, and the curve could remain flat and possibly even invert in the months to come.
I don’t know about you, but I sort of feel like I am stuck in the air on a seesaw, my legs dangling over the sides, as I watch the Fed on the other side, holding my weight in the air. The Fed is looking right at me and smiling, and I am not sure if the smile is a wicked one while it hatches a plan to let me tumble on the other side. The stakes are high and the other kids on the playground are all quickly surrounding us. I am hoping that the Fed’s smile is one of joy and confidence, while the yield curve is betting otherwise.
WHAT’S SHAKIN’
The Mosaic Co (MOS) is trading lower by -2.15% in the pre-market. Possible success in Ukrainian / Russian peace talks mean that fertilizer prices may recede. Russia is the world’s largest producer of fertilizer and Mosaic’s stock price posted recently strong gains in response to the conflict. Dividend yield: 0.66%. Potential average analyst target upside: -6.9%. WHY IS THIS NEGATIVE? Because the current stock price is higher than the average analysts’ 12-month target. While this may be interpreted as a stock being expensive, it does not mean that shares cannot continue to rise.
Tesla Inc (TSLA) shares are higher by +1.43% in the pre-market. The rise is a continuation of yesterday’s +8.03% climb after the company announced plans for a stock split. Investors are betting that Tesla is making the move so it may be considered for inclusion in the Dow Jones Industrial Average. Potential average analyst target upside: -15%. WHY IS THIS NEGATIVE? Because the current stock price is higher than the average analysts’ 12-month target. While this may be interpreted as a stock being expensive, it does not mean that shares cannot continue to rise.
YESTERDAY’S MARKETS
Stocks climbed yesterday as crude oil pulled back and muted some inflation anxiety. The S&P500 rose by +0.71%, the Dow Jones Industrial Average climbed by +0.27%, the Nasdaq Composite Index traded higher by +1.31%, the Russell 2000 Index broke even, and the S&P500 ESG Index gained +0.82%. Bonds gained ground and 10-year Treasury Note Yields fell by -2 basis points to 2.45%. Cryptos climbed by +9.50% and Bitcoin traded higher by +4.03%.
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