Treasuries Screaming; Stocks Yawning

For the second week in a row, the S&P500 barely budged. After the prior week’s unchanged result, last week the index inched down very slightly—by 0.15%. Volume was abysmally low, so there was very little conviction behind the selling, which makes sense since the index moved so little in price anyway. On the other hand, volatility did rise, and this is a cause for concern. The VIX index jumped from near the lows of the year to the mid-teens.

In economic news, the number of reports was on the light side, but as usual, the news was mostly poor. Gallup consumer spending fell. The labor market conditions index also deteriorated. Productivity, while meeting expectations, also fell by quite a large percentage; this drives up unit labor costs, which in turn puts downward pressure on corporate profits. Consumer credit rose by much less than expected. And consumer sentiment came in below expectations. On the positive side, initial jobless claims were a bit better than expected and wholesale trade beat consensus estimates.

The technical picture is once again showing a stock market that has lost its upward momentum (two weeks of essentially no change supports this argument) but near or at record high levels, which suggests that the risk to the downside is greater than the risk to the upside…..over the next few weeks. This potential turn is quite visible on the daily charts and it’s also visible on the longer-term weekly charts where the nearly two year old topping formation is still in tact.

Finally, the global government bond market has been sending a danger signal lately. Over the last several weeks, the yields of not only the US Treasury market, but also the yields in Europe and Japan have been crashing. In Japan, the 10 year government bond has been offering a negative yield for many months now, and in Germany, the 10 year government bond is essentially yielding 0 percent. In the US, the 10 year Treasury is approaching the lows of the year (in terms of yield).

What does all this mean?  The biggest takeaway is that huge and mostly sophisticated money is running for cover. By accepting near zero or even below zero yields, these big money investors are saying that they’d rather lose a little bit of money (and guaranteed to do so) rather than risk losing a lot of money in the risk asset markets such as stocks and high yield corporate debt.

The problem is that stock markets (in the US especially) and the junk bond markets have not behaved in a manner consistent with global government bond yields; instead, they have held onto or near record high prices.

So it’s almost a certainty the this discrepancy, or divergence, will not continue. And the big question is how will this divergence correct itself—will government bond prices fall…..or will risk asset prices fall?


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