It is World War II. There is a popular sentiment and preference for military servicemen to avoid chatter that might give away tactical war plans. Literally, such unguarded conversation could tip off the enemy and result in the sinking of ships. The etymology of this idiom, “Loose lips sink ships”, is more broadly applied to the concept of “beware of unguarded talk.”
Well, loose lips sink ships applies today. Loose lips (and tweets) can sink markets…and so can program traders. On Tuesday, December 4th, domestic equity markets sold off substantially. The S&P 500 and the Dow Jones Industrial Average were down 3.24% and 3.1%, respectively. The signals were there that quantitative trading programs took the markets lower – high volumes and indiscriminate selling being signposts.
What happened? Here are a few headlines from Bloomberg within the last 18 hours.
- “Trump Whipsaws Markets Again With Habit of Overstating Success”
- “Stock Vigilantes Show Trump Who’s Boss”
- “China Swings to Trade Action as ‘Tariff Man’ Trump Ups Pressure”
On November 21st, we published a Reed Between the Lines edition titled, “Rudderless Markets?”. In this post, we suggested the deck hands (market participants) were acting like the economy was going into a recession…that the ship was sinking. It isn’t. We highlighted concerns for tariffs & trade wars, a slowing global economy, increasing Fed Funds interest rate hikes and corporate earnings as being the culprit for a market sell-off that took the S&P 500 into negative territory for the year-to-date period. We also highlighted that potential catalysts for the market could be positive news on the China/U.S. tariff front and more dovish (i.e., backing off interest rate hikes) comments from the Fed. We received those dovish comments from Federal Reserve Chairman Powell days later and over this past weekend we received favorable comments (tweets) from President Trump on the China/tariff front. As the following exhibit highlights, this was all well received as the S&P 500 climbed nearly 6% through Monday since the recent low and our last publication.
Interest Rate Update
The market likes the fact that the Fed may be signaling a slow-down in rate hikes. The market just doesn’t see the need for hikes when inflation is in check. If inflation is in the 2% to 2.5% range and the Fed Funds rate is at 2.25%, then that is at or near a neutral position. The Fed stated they may be just below that neutral range. All positive, right? The likelihood of three or four rate hikes next year is growing less and less likely.
Tariff Talk Update
President Trump’s boast of an agreement with China’s President Xi Jinping over the weekend rallied markets further on Monday. By the time Tuesday rolled around, market strategists were questioning the actual details. China didn’t provide robust commentary as support. President Trump and Larry Kudlow, National Economic Council Director, started walking back comments. Markets dropped.
Interest Rate & Bond Market Perspective
The bond market wasn’t buying the tariff proclamations either. The concern for tariffs escalated, resulting in concern for slowing global growth, resulting in lower concerns for inflation and the need to hike interest rates, resulting in more sellers of bonds than buyers, resulting in lower yields, resulting in an interest rate inversion (U.S. Treasury rate 2-year 2.795% higher than 5-year 2.787%). While this is concerning, we are more interested in watching the 2-year to 10-year rate spread (2.795% vs. 2.914%). An inverted yield curve is a sign that the market thinks the Fed is wrong regarding their monetary policy – market dictates long-term rates and Fed determines short-term rates. It is also a sign that a recession may be on the horizon – on average 18 months away.
The U.S. markets are closed on Wednesday, December 5th, in observance of President George H.W. Bush. We suspect that rational minds take over and things ease. The administrations of the two largest economies in the world (U.S. and China) are incented to calm the waters. In fact, during Wednesday (late night Tuesday, early morning hours Wednesday in U.S.) China is reporting action on the tariff front. And, President Trump has signaled that despite the fact he is the ‘Tariff Man’ (as highlighted in a tweet), he believes a deal with China will occur. On a side note, international developed and emerging markets are performing well of late. Even after Tuesday’s sell-off, emerging markets are up 5% since November 21st (date of our last post), while international developed is up 2.9% and U.S. up 1.9%. In the meantime, ignore the noise, ignore program traders, stay calm, stick to your plan and invest on.