Once again the computerized trading algorithms are back. These beasts are programmed to be triggered by a single event or a simple tweet. Today’s selling was triggered by an inversion between the 2-year Treasury note (1.63%) and the 10-year Treasury note (1.58%). Historically speaking, this specific inversion signals a recession ahead, beginning anywhere between 6 months and 18 months in the future. By now you know my thinking when it comes to yield curves predicting what’s ahead for the economy. The 10-year is being driven lower by global sovereign money looking for a positive yield. Last night’s economic data out of Germany showed that the largest economy in Europe contracted in the 2nd quarter by -0.1% after a +0.4% increase in the 1st quarter. This data all but guarantees that the 10-year German bund will stay yielding -0.50% (-0.656% today) for some time to come.
The U.S. economy is in good shape right now and being supported by the consumer who accounts for 2/3 of GDP. Lower interest rates and strong employment continue to bode well for strong consumer spending going forward. The Fed will no doubt cut rates again in September which should increase the tailwinds pushing the economy. That said, Trump’s trade war is absolutely having a negative impact on U.S. agriculture, manufacturing and global growth. If he wants to get reelected in 2020, he will need to come to some sort of compromise with the Chinese before the end of this year so the economic engine can ramp up and regain steam over the first 10 months of 2020 as we head toward the presidential election.
I understand that these declines make for good press, and I also know that they can be unnerving for investors but please remember, these are nothing but machines programmed to act on momentum. The algorithms are written to automatically increase selling the more the market declines. There isn’t a human being alive that would trade like this. We must be prepared for more selling if the 2 to 10 inversion gets worse, but as long as there is fallibility in the predictive nature of inversions, I think I am once again, a buyer of U.S. stocks as they get sold indiscriminately.
Finally, I must come back to my belief that the market is supported by the 3-legged stool. These are fundamentally sound and well-tested positions that I always revisit and check when markets get rocky. The first leg is how healthy are the banks? Every financial calamity going back to the Great Depression was triggered by an unsound and unstable banking system. Today, we have just the opposite, U.S. banks are as well capitalized as they have ever been in history. The second leg is corporate profits. Are they rising or falling? Today, after 2nd quarter earnings are nearly complete, U.S. corporate profits have risen again quarter over quarter. In fact U.S. corporate profits have risen every year since 2016. Finally, the last check is to determine whether the Fed is tightening or loosening. We all know the answer to that one. Monetary policy has become loose and it will continue to follow that path for the foreseeable future. The three legs of the stool are super strong!
Let’s continue to hang in there together.