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16 August, 2019 Market Commentary

Bond Yields Invert Suggesting Recession Risk


Market Commentary for the week ending August 16th, 2019

Summary

  • The yield between 2-year and 10-year U.S. government bonds inverted in a sign a recession is nearing
  • For the second week in a row stock prices initially plunge but then recovered to close with just modest losses
  • Hong Kong stocks closed fractionally higher for the week in spite of the continued demonstrations and rising tensions

 

Market Performance Summary

Source: www.YCharts.com

Notable Market Headlines

It’s considered normal when long-term interest rates are HIGHER than short-term interest rates due to bond investors taking more risk with longer term bonds and demanding a higher return. This flipped upside down midweek when the yield on 10-year U.S. Treasuries dipped below the yield on the 2-Years. The three most recent recessions in the U.S. have been preceded by this same inversion. Some market observers see this as a sign that investors anticipate lower future inflation, and therefore slower economic growth, resulting in lower long-term interest rates. There’s another argument that this is simply an issue of supply and demand with central banks buying up more long-term bonds resulting in the lower yields.

The bond market action as well as the unrest in Hong Kong surrounding the demonstrations were both pointed to as driving stock prices lower. This negative news though was offset by Trump delaying some tariffs on Chinese goods as well as some better than expected economic news that apparently helped move stocks higher. When it was all said and done U.S. large stocks, as measured by the S&P 500, were lower for the week by -1.0%. The NASDAQ held up slightly better for the week losing -0.8% while the Dow Jones Industrials declined -1.5% as it contains more stocks that investors believe will be more negatively impacted by the continued trade war. Small stocks were down -1.3% for the week. Since hitting its all-time high less than a month ago, the S&P 500 is now down just -4.5% and is still holding onto an impressive year-to-date gain of +16.7%.

Stocks were not only lower in the U.S. but around the world with international developed markets off -1.1% for the week. The worst performing was Germany’s market losing -2.6% partially impacted by news its economy contracted in the second quarter by -0.1% giving investors yet another economic indicator clearly demonstrating a world-wide economic slowdown. Emerging markets faired a little better losing just -0.8% overall the Hong Kong market actually notched a very small gain in spite of the ongoing demonstrations and rising tensions.

Gold was the best performing of the asset classes we track for the second week in a row gaining +1.1% as investors seem to be flocking to it during times of heightened stock market volatility. Real estate stocks were also higher for a second week in a row, bucking the overall market’s moves, gaining +0.4%. Year-to-date gold is higher by +17.8% and real estate by +20.2% both topping the performance of the S&P 500. Commodities were lower by -0.9% on a continued drop in the price of oil.

Bonds were a huge part of the story this week in the markets with overall prices moving higher by +1.0% and now higher by +8.9% so far in 2019. It was not only that bond prices continued higher, driving yields lower, but that the yield curve inverted with shorter-term 2-Year Treasuries temporarily yielding more than longer-term 10-Years. As the accompanying graph shows, yields are lower today across all maturities as well as the curve inverting.

Source: www.WSJ.com

Stock Highlights

Walmart (WMT), the retail giant that has been fighting the growing dominance of Amazon (AMZN), reported strong earnings for the second quarter serving as another sign in the health of the U.S. consumer. Total sales, earnings per share, and same-store sales growth were all positive and better than Wall Street had expected. Furthermore e-commerce sales surged +37% with management reiterating its expectation of +35% for the full-year.

Walmart remains far larger than Amazon with annual revenue at Walmart of $518 billion compared to Amazon’s $252 billion. Furthermore, as the accompanying graph shows Amazon’s sales growth has been slowing the past 4 quarters but still remains multiples that of Walmart.

Source: www.YCharts.com

At the closing bell this week it was good news for Walmart investors with the stock higher by +5.3% and is now up +21.3% year-to-date.

Tapestry (TPR), a retailer of brands such as Coach, Kate Spade, and others, not only reported disappointing quarterly results but went on to say the future does not look so bright. Total sales came in at $1.51 billion, shy of Wall Street estimates, with earnings per share that were also below expectations. It’s Kate Spade stores were the primary culprit as same-store sales fell -6% compared to expectations of a small gain. The stock got slammed for the week down -27.1% and is now off its 2018 high by -63.4%.

Several other retails suffered this week as well as highlighted in the accompanying table:

Source: www.YCharts.com

Cisco (CSCO), the world’s largest supplier of networking solutions, reported higher sales and earnings for the quarter with both topping Wall Street estimates. When digging into the numbers though there was a -21% drop in sales to service providers, providers focused on the buildout of the new 5G network, as well as management providing disappointing guidance for the coming quarter. The stock fell -10.4% but is still higher for the year by +8.4%.

Other headlines and stock movers…

  • Dollar Tree (DLTR), a discount retailer, is seen as benefiting from a delay in tariffs on Chinese goods. It’s stock rose +4.0% for the week and is up +3.8% for the year.
  • NVIDIA (NVDA), a specialty chip maker, reported better than expected earnings. The stock gained +3.5% for the week and is up -19.5% year-to-date

Economic Indicator - Reported

The U.S. consumer continues to open its wallet as July retails sales during July rose by more than double economists’ expectations at +0.7%. This strength bodes well for the overall economy as retails sales account for approximately two-thirds of economic activity. The strong growth during the month was seen at internet retailers as well as strength at brick and mortar department stores, restaurants, and electronics outlets.

Inflation remains mild as the Consumer Price Index (CPI) ,a measure of retail inflation, was reported higher by +0.3% for the month and +1.8% over the past year. Higher rents, gasoline prices, and computer prices were among the items adding to the cost of living while grocery prices were down.

U.S. productivity, a measure of how efficiently work is being done, rose by a healthy +2.3% for the second quarter which follows a revised +3.5% gain in the first quarter. These two quarters put the year-over-year growth at the strongest level since 2015.

Economic Indicators – Upcoming

The following economic data are expected in the coming week:

  • New Home Sales
  • Existing Home Sales
  • Leading Economic Indicators

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