4 Updates, 1 Conclusion

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4 Updates, 1 Conclusion

With an eventful August finally winding down, today we want to update you on 4 topics we have written about this month.

#1: Comparisons to August 2015:

  • In our report on August 5th we compared current market conditions to those in August 2015.
  • August 2015 was a bad month for US stocks, with a 6.3% decline for the S&P 500 and 4 consecutive days of torrid volatility. The index fell by 10.1% from August 20th to the 25th, and there was a flash crash at the open on the 24th.
  • August 2015 was volatile because of a surprise devaluation in the Chinese yuan, which markets took as a warning sign of slowing economic growth that could cause a global recession.
  • There were, however, no worries about a US-China trade war.

Here is how August 2019 lines up so far and what it might say about the rest of this week:

  • With today’s rally the S&P is down 3.4% for the month, not as bad as the 7.7% decline through the same timeframe in 2015.
  • Unlike August 2015, this month’s volatility has episodic rather than concentrated. There have been 3 days of +2.5% drawdowns, but they have been spread out over several weeks.
  • Today’s 1.1% move higher lines up against a 3.9% rally on August 26 2015, as markets began to climb out of their hole.
  • The rest of the final week of August 2015 was good for US stocks, up a further 1.6%.

Takeaway: while August is typically a choppy month for US stocks, the comparison between 2015 and 2019 shows that volatility comes in different flavors.

  • In 2015, markets saw a short, sharp shock and the CBOE VIX Index spiked to a closing high of 41 on August 24.
  • In 2019, we’ve seen single-day drops in response to trade news, but every time that happens the next day is flat or higher. As a result, the VIX has closed below 20 almost 3x more often than above that number, its long-run average.

#2: Google searches for “dow jones”:

  • While the S&P 500 is Wall Street’s preferred measure of stock market performance, Main Street googles “dow jones” when they are worried about stock market volatility.
  • In our report on August 8th we noted that US-based Google searches for “dow jones” were higher than during the May 2019 selloff.
  • We viewed that as troubling, because between stock market volatility and more chatter about recession indicators flashing red we worry the US consumer will grow more cautious heading into Holiday 2019.

Here’s where this indicator stands now:

  • Google searches for “dow jones” for the week of August 11-17 (last week of complete data) are 28% higher than their peak May week (12 – 18).
  • On the bright side (ish)… Google search volumes are still 14% below 12-month highs set during the last week of December.

Takeaway: even if the average American does not own equities, they know that volatile stock markets signal the possibility of job losses and even recession. December 2018’s spike in attention was washed away by January 2019’s stock market rebound. We’ll have to wait to see how markets perform over the rest of 2019, but one thing is sure: Americans are watching.

#3: European bank stocks:

  • On August 19th we discussed what some market watchers are calling the ultimate global canary-in-the-coalmine indicator: the horrible price action in European bank stocks.
  • The index used to measure the group’s performance, the EURO STOXX Bank Index, is heavily weighted to the economically weakest countries in the Eurozone: Spain (30%), France (23%) and Italy (19%).
  • The index sits not just at post-Financial Crisis lows, but those going all the way back to December 1987. European banks are clearly facing a perfect storm, ranging from negative interest rates to recession fears, undercapitalized balance sheets/inefficient cost structures and incremental capital regulations.

Here’s the latest on the group:

  • The EURO STOXX Bank Index continues to bump along the bottom, with a close today of 79.61, slightly lower than when we wrote about it on the 19th (79.84).
  • One chief culprit for the group’s underperformance – persistently negative Eurozone sovereign rates – remains a problem. German 10-year bunds may be crawling off the lows of -0.70% set on the 15th, but remain solidly negative at 0.66% today.

Takeaway: the health of the European banking system remains tenuous, one reason why the region’s negative-rate monetary policy has had limited efficacy. With Financials a 19% weighting in the MSCI Europe Index, this group’s significant problems are one good reason to steer clear of the area from an investment standpoint.

#4: US Yield Curve/Long Rates:

  • On August 14th we posited that the selloff that day (-2.9% on the S&P 500) was more due to a 10-year Treasury yield at 1.581% than the inversion of the 2-10 year Treasury spread.
  • We also noted that since 1962 the 10-year Treasury has only sported a lower yield than 1.58% on 45 days (0.2% of the time, solidly in 3-sigma territory).
  • We also highlighted work by AQR’s Cliff Asness which shows the 10-year Treasury is extremely expensive and in our August 19th report showed that the trailing 1-year return on the 10-year (13.1% after inflation) is well over 1 standard deviation (8.9 points) from the long run average post-inflation return (2.0%)

Here’s the latest:

  • As of today the 2-10 Treasury spread is essentially flat: 1.543% yield on 2s, 1.538% on 10s.
  • 10-year Treasuries remain in rally mode, with a closing yield today of 1.538% versus that 1.581% print on the 14th. Much of this is due to lower inflation expectations, with 10-year TIPS spreads down 0.03 points (70% of the decline in yields) since mid month.
  • Also worth noting: the driver of the much-watched NY Fed Recession Predictor – 3 month Treasuries minus 10-years – keeps breaking down to new lows. Barring a sudden reversal over the next 3 days, expect to see the Fed’s model show increasing odds of recession when the next update posts in September.

Takeaway: the drumbeats from the bond market threatening a US recession continue to grow louder. If one arrives, however, it will be the first one since 1973 that did not come with a doubling of oil prices that pressured US consumer spending.

On that point, and summing up: will uncertainty about US-China trade create the same economic havoc as a 2x increase in gas prices? That seems a stretch, but we understand the concern:

  • Point #2 shows Americans are watching recent stock market volatility, and if it spills over into September-October that will not bode well for holiday spending.
  • Point #3 – the weakness in European banks – hardly inspires confidence.
  • In the end, we come back to the same message that has run through our notes in recent weeks: expect more volatility in September/October.
  • Our Strong January Playbook shows that we’re not out of the woods, and both months could easily show negative returns if history repeats itself. And given what we’ve shown you today, that seems a reasonable base case.