Friday, December 20, 2019

"Steeper Yield Curve & Improving PMI"

Just a reminder:
Remember, there are two ways to steepen the curve: the bad way, the Fed lowers the short end reacting to weakness; the good way, the market raises the longer end anticipating strength.
That's me, quoting myself.
The yield on the 10-year is  1.9210%  +0.013%

From Upfina, December 19:
The yield curve has steepened very quickly in the first half of December. As you can see from the chart below, the difference between the 10 year yield and the 2 year yield has gone from 14 basis points on November 27th to 29 basis points which is near the highest since November 2018.  
The yield curve was only inverted for 3 days. The enticing wait for the yield curve to invert and then precede a recession was highly anticlimactic as there has been no recession. The median Q4 GDP growth estimate is 1.9% which is exactly what the Fed sees as the long term average growth rate.
We have stated the inversion was more about pricing in Fed policy than preceding a recession. Normally, there is a recession as the curve quickly normalizes. It’s still relatively flat, but if it continues on this steepening path, there would be normally a recession. However, there is no evidence of a recession occurring soon. Currently, the curve is steepening because the 10 year yield is rising due to increased nominal growth expectations. The 2 year yield is being suppressed by the fact that Powell has stated he needs to see sustained high inflation for the Fed to raise rates. That explains why there is a 1.1% chance of a hike next year. Without hikes, the 2 year yield won’t increase. However, the next move might be a hike further down the road if the recovery progresses.

Improved (Flash) Markit PMI
The flash December Markit PMI hit a 5 month high as you can see from the chart below. This wasn’t a good report on an absolute basis as it’s consistent with just 1.5% GDP growth. However, it was good on a rate of change basis as it signals the slowdown could be ending....MORE
Just so you know, we are no Pollyannas-come-lately.
We've been sharing our sunny bit of optimism on the yield curve, economy and equities for a while:
See June 18's "Just a Reminder: Riding the Bubble Can Be Very Profitable":
Last Friday we had a post linking to Albert Edwards' latest on bonds with this outro:

Whether you are using the 3 mo./5 yr; the 3mo./ 10 yr. the 2's/10's whatever, the period after the inversion can give you stupendous equity returns so we are faced with the decision whether-or-not to play a dangerous little game, riding the bubble knowing full well it is a bubble or retiring to the sidelines.
We'll have more on the time lags between yield curves going inverted and equity downturns and recessions later this summer but for now one of our favorite economists with one of our favorite stories....
Or February's "Rhyme Time at the San Francisco Federal Reserve Bank: "Did the Yield Curve Flip? Will the Economy Dip?"
The curve is not yet important. We (possibly delusionally) think we'll be able to tell you when it is.... 

Or last December's "Blackstone's Byron Wien Seems Chipper, Almost Jolly":
Remember early December? Everyone was talking yield curve around the clock. And so were we. Here's the outro:
note: the above was written before the 2's/5's or 3's/5's or whatever the fashionable bit of the curve that makes the inversion case, inverted.
At the moment the curve doesn't matter, if and when we think it does, you can rest assured we'll go "curve, curve, curve" 24-7.

For now, as a commenter—I forget where—said: "I think the pundits just like saying 'inversion'".
Inversion. It's almost soothing, in a paradoxical kind of way.
Personally, I like paradoxical. More consonants.
And equities?
Here's November 26's "Recession Warning Of Inverted Yield Curve Looks So Last Year"
So where are we at right now? For the moment long ain't wrong and our three-year-old target of 3300 on the S&P—appropriated from Jeremy Grantham before he chickened out and started disavowing the upside, even going so far as invoking the "I'm always right" "down to a 40% chance".
Right now we are in a multiple expansion phase for the U.S. indices while the rest of the world gets some economic growth footing.
S&P 500     3,136.43     +2.79  (+0.09%)  
Or a little more braggadocios, November 18: "Equities: How's My Driving?"

Back to the curve. If all this repetition has one takeaway, it is:
November 12
"Is The Entire Yield Curve Wrong?"
...The problem  with the analysis of the yield curve resuming its upward sloping configuration as a harbinger of recession is that the curve usually un-inverts because the Fed forces down short-term rates, which indeed has happened, but which has also been accompanied by a rise in long-term rates.
The 10-year yield got as high as 1.9710 on November 7 and made a post from September 30 look prescient:
Equities: "Financials Are About To Do Something They Haven't Done In Nearly 18 Months" (XLF; KBE)
Our two cents was in the outro:

The 10 - year is currently yielding 1.697 % +0.024, so looking for rates to back up to (and through) 1.90% is a bit of a contrary bet but if it happens bankers (and longs) will be happy.  
Banks and longs are indeed happy with the KBW Bank Index leading the broader market and outperforming by a very big margin. Since October 2 the BKX is up 14.4% versus 6.2% for the Dow Jones Industrials and 6.9% for the S&P 500.
So what now for the broader market?
Higher by year-end, probably enough turbulence between now and then to shake loose some stock from ma & pa investor.
We'll have more next week.
Also at Upfina, December 18:
No Recession In At Least 2 Years?