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Stocks May Be Peaking, But the Real Story Is The Treasury Rally

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the Real Story Is The Treasury Rally

Written by: Leo Kolivakis

Fred Imbert of CNBC reports stocks fall on trade war fears, sending the S&P 500 to its worst week of 2019:

Stocks fell on Friday as President Donald Trump stoked U.S.-China trade fears with the announcement of more tariffs while investors digested U.S. employment data.

The Dow Jones Industrial Average closed 98.41 points lower at 26,485.01 after plunging 334.20 points earlier in the day. The S&P 500 lost 0.7% to end the day at 2,932.05. The Nasdaq Composite slid 1.3% to close at 8,004.07. The major indexes dipped below their 50-day moving averages, key technical levels watched by investors.

Equities took a major blow this week. The S&P 500 and Nasdaq dropped 3.1% and 3.9% this week, respectively, their biggest weekly drops of 2019. The Dow had its second-worst week of the year, sliding 2.6%.

Caterpillar and Deere, two stocks associated with trade because of their overseas revenue exposure, both fell more than 1.5%. The VanEck Vectors Semiconductor ETF (SMH) dropped 1.4%, led by a 4.2% decline in Skyworks Solutions.

In a series of tweets on Thursday, President Donald Trump said the 10% charge would be imposed on $300 billion worth of Chinese goods. The levy will take effect starting September 1. Trump said later on Thursday he was open to shelving that tariff if China stepped up its U.S. agricultural purchases.

“The markets were already up to their plateful digesting the impact on earnings and the economy before yesterday’s announcement,” said Tom Martin, senior portfolio manager at Globalt. “But China and the U.S. were working it out and as long as another shoe didn’t drop and it didn’t escalate, things were going to be OK.”

“Then you get this announcement,” Martin said. “There is some real uncertainty introduced with it.”

The move breaks a truce in the long-running trade war between the world’s two largest economies, with investors fearful it could further disrupt global supply chains.

China’s foreign ministry pushed back against Trump’s latest tariff threat on Friday morning, reportedly saying the world’s largest economy should give up its illusions, shoulder some responsibility and come back to the right track on resolving the trade war.

China’s spokesperson at the foreign ministry, Hua Chunying, said at a daily press briefing that Beijing would have to take countermeasures if the U.S. was committed to putting more tariffs on Chinese goods, Reuters reported.

Trump’s tariff threat came as a surprise to financial markets in the previous session, in large part because negotiators for the two sides had just met earlier this week in China.

John Augustine, chief investment officer at Huntington Private Bank, highlighted the consumer discretionary and tech sectors have fallen sharply this week. “The market is anticipating this could affect U.S. consumer spending, which we have seen strengthening recently,” he said.

Jobs growth in line with estimates, wages rise more than expected

The U.S. economy added 164,000 jobs in July, just below a Dow Jones estimate of 165,000. The job gains pushed the size of the U.S. labor force to a record high.

Wages topped analyst expectations. They rose 3.2% on a year-over-year basis, surpassing a Dow Jones forecast by 0.1 percentage points.

The strong wage number could be seen by traders as a sign of rising inflation, which could keep the Federal Reserve from cutting rates multiple times later this year. The Fed cut interest rates by 25 basis points on Wednesday.

“The in-line July jobs report doesn’t really change the macro outlook much. But equities have other problems,” said Alec Young, managing director of global market research at FTSE Russell. “They’re being squeezed by a double whammy. On the one hand, Wednesday’s Fed outlook was less dovish than hoped, while President Trump’s latest consumer-focused China tariffs significantly dented the already soft global growth outlook.”

Last week, I discussed whether a summer melt-up in stocks is upon us and noted the following:

What is astounding, however, is that equities bounced back strongly after the bad Santa selloff of 2018and they haven’t really let up at all.

Year-to-date, the S&P 500 is up 21% led by tech shares which are up 33%:

And the Fed is cutting rates because inflation expectations remain stubbornly low!

If the dips continue to be bought and we get more record highs on the S&P 500, Nasdaq and Dow Jones, I suspect people are going to be worried about a good old fashion summer stock market melt-up.

In my opinion, things are heating up too much in stocks but the algos are driving them higher and higher and fundamental investors are going to end up chasing them higher or risk another year of severe underperformance.

This week, the Fed cut rates by 25 basis points but the yield curve flattened, signaling that bond traders aren’t as confident as Federal Reserve Chairman Jerome Powell that what he calls a “mid-cycle adjustment” in rates will be enough to keep the economy expanding:

Some traders are “unhappy with the fact that the Fed viewed these cuts as being more of a mid-cycle adjustment than the beginning of a new easing cycle,” said Scott Buchta, head of fixed-income strategy at Brean Capital. “Some people were expecting future rate cuts to be on autopilot rather than data-dependent.”

Let’s face it, the Fed is flip-flopping with every move in the market.

And President Trump is adding fuel to the fire, the timing of his tweet to impose more tariffs on China came a day after the Fed cut rates by 25 basis points. Trump is on the record stating he wants more rate cuts, so he’s doing his part to force the Fed to cut again in September.

But the big story this week was the rally in US long bonds, including the 10 and 30-year Treasury notes. Have a look at the iShares 20+ Year Treasury Bond ETF [ (TLT[NSD] – $138.23 1.72 (1.27%)    Trade )], a price index of US long bonds:

It’s breaking out, making a new multi-year high. I’ve been long US long bonds for a very long time, and scoffed at the bond teddy bear market in February 2018 (another opportunity to load up on bonds).

Yes, stocks are hitting record highs but on a risk-adjusted basis, US long bonds are creaming equities over the last year.

The 10-year US Treasury bond yield closed at 1.85% on Friday, a 22 basis point move lower this week. No doubt, a lot of this is due to events going on outside the United States where sovereign bond yields are trading at negative levels.

In fact, Jim Bianco of Bianco Research posted this on LinkedIn: “Negative debt expanded by a record $650 billion on Friday (Aug 2). Total negative debt is a new record at $14.52 trillion. Negative debt is now 26.3% of all sovereign bonds, also a new record.”

Weak global PMIs are weighing down US bond yields but I’m not sure we are headed much lower unless something blows up in China sending another global deflationary tsunami our way. If that happens, the yield on the US 10-year note will slice below 1% and hit a new secular low.

Right now, I’m not really bullish on bonds or stocks. Think CTAs are driving these latest moves and I’m more defensive, pretty much all in cash and not really interested in buying anything.

Some market watchers think there’s way too much exuberance in the stock market and I tend to agree:

This sustained period of exuberance means that it will take more than just a day or two of market drops to work off the excess optimism. That’s why the stock market was unable to sustain its attempt at a big rebound on Thursday of this week, for example. Commentators will attribute Thursday’s reversal — from the Dow Jones Industrial Average up more than 200 points to close down almost 300 —to the new tariffs on Chinese goods announced by President Donald Trump. But, as with the Fed’s rate cut decision, these new tariffs are little more than a convenient excuse for a market that was ripe for a fall.

But the quants and CTAs are still bullish on stocks and you saw it this afternoon when the Dow Jones came back to close way above its lows of the day.

Dip buyers are alive and well, so I wouldn’t rush into predicting the demise of stocks just yet, unless you get a deflationary scare out of China. For me, this week was just normal profit-taking, selling the news after the Fed cut rates.

Also, Jurrien Timmer, Director of Global Macro Research at Fidelity wrote an interesting comment on why the bull could still have legs citing these key points:

  • If corporate earnings rebound into 2020 as expected, any upcoming Federal Reserve interest rate cuts may well extend the business cycle expansion even further.
  • The Fed has a free option to cut interest rates, given persistent low inflation.
  • Despite high valuations, I think this 10-year-old bull may well have some life left in it.
  • While bears may refer to this bull market as an “everything bubble,” the fact is that the S&P 500 is only 10% above its central trend line, far short of its level in previous bubbles.

First, Chris Wolfe, CIO of First Republic Private Wealth Management; Jared Woodard, investment strategist at Bank of America Merrill Lynch Global Research; and Michael Zinn, senior VP of Wealth Management and senior portfolio manager at UBS Financial Services, join CNBC’s “Closing Bell” to discuss the week’s market action.

Second, Diane Swonk of Grant Thornton and David Rosenberg of Gluskin Sheff join “Squawk on the Street” to discuss the jobs numbers for June and the Fed’s decision to cut interest rates.

Third, Bill Simon, former CEO of Walmart U.S., joins “Squawk on the Street” to discuss President Trump’s escalation of tariffs against China amid trade talks.

Fourth, Katie Stockton, founder and managing partner at Fairlead Strategies, joins CNBC’s “Closing Bell” to discuss falling yields in the treasury market as the 10-year yield is on pace for its biggest weekly drop since June 2012.

Lastly, PIMCO’s Tiffany Wilding, US economist, and Scott Mather, CIO US Core Strategies, discuss how the Fed’s 0.25% rate cut may affect markets, including 10-year US Treasuries, and where rates are likely to go from here.

Update: Following the devaluation of the yuan over the weekend, which might have been engineered by the PBOC, a lot of CTAs and quants were caught with their pants down shorting vol, leading Nomura’s Charlie McElligott to warn of an extreme negative gamma selling avalanche.

Related: Expect More Volatility Ahead with Every Tweet and News Report

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