After losing ground the previous week, the S&P500 bounced right back and gained 1.2% last week. Volume was light, which has been very typical in this multi-month advance. And volatility crept back down—the VIX index dropped back to the lower teens.
What was odd about the advance in the US stock market is that it happened during a week when the US economic reports were exceptionally weak. Well over 10 reports disappointed, when compared to consensus estimates. And only a handful beat their respective estimates: consumer sentiment, new home sales, and international trade in goods. So investors are beginning to look beyond the dismal economic data and instead, they’re starting to bank on more monetary easing from the Federal Reserve, which is now—at least in the view of the markets—expected to cut interest rates in 2020, instead of hiking them as everyone had expected in 2018.
This massive shift in expectations for US monetary policy has not only helped to prop up the stock markets over the last couple of months, but it has driven down longer US interest rates dramatically. The US 10 year Treasury yielded over 3.3% last fall; last week, it dropped all the way down to a 2.3% handle.
Another more ominous interpretation of this drop in US Treasury yields is that the Fed has over-tightened in the last 12 months. As a result, the odds of a recession in the US have risen dramatically…..and the drop in US yields reflects the bond market’s anticipation of this upcoming recession.
Ironically, if this recession materializes, then corporate earnings….and presumably US stock prices…would fall. So we are now witnessing a dramatic divergence between the US Treasury market and the US stock market, where the Treasury market is bearish and the stock market is bullish.
This divergence will not be resolved over a couple of days or weeks; it will likely take several months. And when it does get resolved, one of these markets will very likely get repriced….in a very meaningful way.