Where are we in the cycle?

The yield curve has almost flattened and even both immediately before and just after Fed Reserve jacked up the interest rates by 25 basis points, the US 10-year treasury yield remained much lower than psychological level of 3 percent instead of moving up. The 10-yr yield is now around 2.78 percent --- defying the Fed’s effort of getting it to move up. I think this is an ill omen to the US stock market in that:

1.  When the interest rates keep moving up, as long as the rates are still “tolerable” by the market players, it means the US economy is doing well and investors have confidence that the stock market should be doing well going forward. The declining 10-yr yield is suggesting otherwise now.

2. Fed Reserve jacks up interest rates primarily to tame inflation and secondarily to cool down the market. But now the US market has been so cold that it becomes a mockery for Fed to do just the opposite. Trump was somehow right to try to get Jerome Powell not to hike the interest rates in that sense but the latter knew he could not heed his President’s advice for fear of Mr Market’s negative sentiment as all would think that the u-turn means recession is fast approaching.

3. When the yield curves flatten, it foretells with certain respectable probability that the recession will come sometime later. Historically, the flattened yield curve will lead the recession by 15 months on average.

4. The 10-year treasury yield is another leading indicator for the stock market. If it has lost its upward momentum and retreated, it has signalled in all probability a slowing economy.

Reasons for the current situation

It is actually not difficult to find the causes of this phenomenon: Trump initiated a trade war with China. Mr Market knows that the US has a slight advantage in the trade war, but the outcome of the trade war will be a lose-lose proposition for both countries. The reason why the China market has dropped much more than the US market during the initial phase of the trade war was because of the US tax cuts. But the tax cuts enjoyed by the US listed companies was a one-off event and Mr Market knows too well that this catalyst will evaporate in 2019 and he is now exerting this hard-truth on the US market. Trump’s sledgehammer tactics have come home to roost.  

China, with its market already hovering around its trough, should rebound faster than the US. My crystal ball has been telling me to have patience to wait for its signal.

What is the stage of the current market?

The US market has enjoyed 10 years of growth and with contraction in profit margin, trade tariffs, rising wages, higher interest rates, higher uncertainties caused by Trump’s mercurial behaviour, the good times should be behind us. It is difficult to see the light at the end of 2019 tunnel.

For contrarians, it should present a golden opportunity going forward.

Superphang
https://superphang.blogspot.sg