In general, our opinion is that the overall market tone has changed quite significantly (for the worse) over the past several weeks.
For starters, as noted in a few of the recent quarterly commentaries, yield curve inversions are one of the most closely watched indicators by economists. Yield curve inversions happen when short term rates become higher than long term rates and specifically, the 3-month vs. 10-year treasury yield curve spread has inverted before every economic recession since 1960. Although the 3-month vs. 10-year spread inverted in March (for the first time since 2007), that inversion lasted only six days and hit a low of -11 basis points. The spread inverted again briefly in the middle of May and once again inverted on May 23rd. As of this update, we are now seven days into the most recent inversion but have hit a new low as of today at -18 basis points. From where we are now, it looks like this trend is going to continue with the market pushing the long end of the curve lower through stable short rates because the Fed is not ready to cut … yet.
In contrast to just a few months ago, rising trade tensions and uncertainty exist now between the U.S. and China, the European Union and, as of this morning, now Mexico. Markets don’t like uncertainty, and this has been one of the primary drivers for the declines seen this month. It is still possible that we avoid a full-blown trade war and this ends up being just a well-played game of chess, but right now that seems hard to believe. Morgan Stanley recently
Yet another negative element right now is the continuing signs of slowing growth. The Markit U.S. Manufacturing PMI survey, which tracks sentiment among purchasing managers, came in last week at the lowest level since 2016. Durable Goods Orders also dropped sharply in April and came in at levels not seen since 2016. Furthermore, Q2 GDP was expected to be lower than the 3.1% value in Q1, but forecasts have continued to drop over the past several weeks as more and more economic data is released, and the Atlanta Fed now forecasting only 1.3% for the second quarter. Reporting season is just around the corner as well and it appears to us like we could see a lot more disappointing misses than beats. Finally, there is typically a ripple effect that occurs as corporations start to see a slowdown in growth which causes them to temper their purchasing and manufacturing activities which just ends up causing a further slowdown in growth.
In short, there appears to be more downside risk than upside potential in the coming months and beyond.
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