Two Strange Things About Yesterday’s Selloff

On big down days for stocks I sometimes think about the first line in Leo Tolstoy’s Anna Karenina: “Happy families are all alike; every unhappy family is unhappy in its own way.” Markets are like that too. Every “happy” secular upswing for stocks since 1980 has been a function of rising corporate earnings and lower interest rates. Dour-faced bear markets come from a myriad of factors: the bursting of investment bubbles, geopolitical shocks, Federal Reserve policy, financial crises, and spikes in oil prices, often in some haphazard combination.

Now, we’re still a long way from a bear market for US stocks, with the S&P 500 closing today just 2.1% below its all time high. Which was a week ago. Yes, the Russell 2000 is still 9.1% off its August 2018 highs, but what do you expect from a basket of stocks with just a 17% “real Tech” weighting versus the S&P’s 31%? Equity investors are rewarding tech-enabled and globally scalable business models just now, and very few US small caps – no matter how well run – fit that paradigm.

All that said, today’s price action is still worth a look because bear market narratives, just like unhappy families, don’t just show up unannounced. They invite themselves over endlessly and only so many “So sorry, we’re busy all next month” excuses work on them. You will eventually have to have them over. Same for bear markets – we’ll get one again whether we want to or not, and they will call ahead to make sure we’re home.

Here’s what we saw today that is worth your attention:

#1: Fed Funds Futures and Treasury bond markets did not seem to notice the selloff in global equities:

  • Unlike Monday, when Fed Funds Futures shifted the odds of a 2019 rate cut by 7 percentage points (47% to 54%) today they barely moved. At the close today the odds that rates will be lower in December stands at 56%.
  • The same thing goes for September, which has been the most volatile contract recently. Odds of a rate cut yesterday: 32%. Today: 33%.
  • Likewise, 2-year Treasury yields fell by all of 3 basis points and 10-years by 5 basis points.

Takeaway: we would have thought expectations for a rate cut should climb more in the face of a 2% down day for the S&P. Maybe rate futures saw the equity selloff as more noise than signal. Or perhaps they realize the Fed won’t move quickly absent a visible economic slowdown. Whatever the reason, bond/futures markets were calm today.

#2: There were few places to hide:

  • S&P 500: -1.7% today
  • S&P 500 Value: -1.7%
  • S&P 500 Growth: -1.7%
  • Russell 2000: -2.0%
  • Russell 2000 Value: -1.7%
  • Russell 2000 Growth: -2.2%
  • MSCI EAFE Index: -1.8%
  • MSCI Emerging Markets: -2.0%

Takeaway: Tuesday’s selloff was uniform across market caps and geographic regions. Even though US small caps are supposed to be insulated from the worst of trade/tariff concerns, they declined by more than the S&P 500. And while EAFE has almost no Tech sector exposure – the S&P’s Achilles’ heel today – that didn’t shield the asset class.

#3: The strangest part of all this – the proverbial dog that did not bark – is the dollar, which has been remarkably stable not just today but across recent history.

  • At the end of April it looked very much as if the DXY index would make a new high at +98.2. We wrote about that in these notes as that move was underway.
  • Since then the dollar has pulled back modestly, to 97.55 today (a 66 basis point decline). That’s right where it was in mid-April, when everyone thought US-China trade talks would wrap up this month.
  • The dollar was unchanged today, down to the “penny” on the DXY.

Takeaway: against the backdrop of a trade tension-related equity selloff, we could argue for dollar strength or weakness but not “unchanged”. Strength, because rest-of-world economic growth will falter. Weakness, because US rates have further to fall in a trade war-induced recession than those in Europe or Japan. But what we can’t argue is for the dollar to remain static. And yet that’s what is happening.

Final thought: From a near term perspective, it is hard to square all this with the notion that US equities are through the worst of their recent volatility. In order to make that call, you’d want to see bonds/futures signal a much higher chance of Fed action, for example. And you’d certainly want the dollar to rally, indicating greater bearishness over global growth and risk. Until those markets start to move, equity markets may not be at a near term bottom.

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