Market Musings

By: Erik Moisan

So, after a tumultuous first week of December, when no amount of good news could trump (no pun intended) the bad, we received some net positives on the “noise that moves the market outside of fundamentals” front. The first week of December was subjected to emotions rising over the China/USA tariff spat, which has ebbed, as well as the angst caused by the detaining of the CFO of Huawei. The US intervened, and Canada released her on bail of $10 million. Following this, Trump announced that he would be proud to “shut down the government” if he did not get $5 billion for his border wall…. As the bad news in early December hit, markets got rocky, and then as the resolution/good news was announced (all but on the government shutdown risk), the markets recover. This as I write…. In 12 hours, who knows.

Good golly Miss Molly (as a good friend and mentor would say), things are choppy!

So lets look at “stuff economic and data” once again:

Positives:

This week, The ISM PMI (an economic indicator that we use in conjunction with others to measure risk of recession) not only remains in “non-recessionary” territory, it actually increased from 57.7 to 59.3 (anything over 50 is good).
The relationship between the 2-year Treasury and the 10-year Treasury improved since the slip last week.
US CPI is unchanged. Inflation is present only in certain specific sectors, not at large.
While the number has fallen, still above 70% of 68 economies representing 81% of global GDP (Haver Analytics) are expanding. So it does not look like the global expansion is over. It may not be as synchronized, but this would be normal in a late cycle expansion.
The Conference Board’s leading economic index is still rising (Dynamic Funds and Haver Analytics). Our good friend Myles Zyblock and his team put together a piece on this, and historically, the LEI falls for 1 to 20 months before a recession occurs (going back to 1959).

Negatives:

The Citigroup Economic Surprise Index has fallen again (Yardeni Research), but ever so slightly. This translates into slightly more negative surprises than positive.
Initial unemployment claims have risen (but unemployment remains at the same level).
The CNN Fear & Greed Index is at 11, suggesting that investors’ appetite is weak for risk assets, and that they would be more susceptible to punting than staying the course.

Something that is noteworthy: For many months now, I have been talking about the yield curve as a possible harbinger of recession. Over my years in the business, I have heard this many times; the bond market is market is smarter than the equity market. Historically, when the 2-year yield rises above the 10-year yield, a recession has followed (as mentioned previously, timing is an issue. In one such case, the recession followed 19 months later… a long time to be on the sidelines). Well, something happened last week that grabbed a lot of attention, and make for a lot of media exposure: the 5-year yield fell below that of the 3-year yield… the inversion. And more recently, the 2-year and the 5-year flattened as well.

Now the question is not “is this along the lines of the 2- and 10-year relationship?” It is noteworthy, simply because it makes no sense that the 2-year rate should be above the 5-year rate. Put another way, when was the last time a two or three year mortgage costs a borrower more than a five year mortgage? We acknowledge that this is a bad thing. But how bad? With regard to the 3- and 5- year inversion, to this point, our friend Myles Zyblock did some interesting work on the question as well, and it turns out that it has some predictive value in a historical perspective. Going back to 1965, there have been seven recessions.

On nine occasions during that time span did the 2-/5-year yield curve invert. So not 100% predictive value (actually 77.777%). It is noteworthy. Digging a little further, we identify that in those seven cases where it inverted and a recession occurred, the lapse in time between the inversion and the recession was anywhere from 8.3 months to 27.1 months, with an average of 16.7.

Thus, we remain neutral weighted on both our equity and fixed income allocations. We are currently light exposure on materials and telecom sectors, we are underweight energy in Canada and have an overall global exposure to financial services of 21% in our equity portfolios.

We close off with the following. While this is not an exact science by any means, we believe that we have identified a combination of tools that will aid us in potentially identifying a severe market downturn. At present, none of these markers is indicating an eminent end to the current market cycle.

Our office will be short staffed during the holidays, starting at the close of business on December 21, but we will be able to answer all urgent request and continue to monitor the situation for you. Please email or phone us.

We will resume our musings on January 15.

Wishing you all the most joyous holiday season. May you be surrounded by friends and family.

Happy holidays,

Erik