Apple rots on the vine as lockdowns slow production in China

Stocks swooned as China erupts in protest over COVID lockdown measures – trouble in China could mean trouble for the global economy. Some Fed officials are simply not content with the way in which markets are interpreting Fed policy.

Upside down, downside up. As far back as I could remember, the shape of the Treasury yield curve was a sacred thing. My regulars know that I have this passion for bonds as that is where I got my start in what seems like a generation ago. It has given me a unique perspective on the broader markets, the economy, and yes, even stocks. One of the first things one learns about on a bond trading desk is the yield curve. To be fair, I learned about it in my Money and Banking class in my undergraduate studies, but I was too naïve to put enough import on it until I learned that it was the bedrock of the entire fixed income universe. Indeed, ALL bonds are priced against the Treasury yield curve. So, if it moves up or down, changes shape, flattens, or steepens it effects the prices of just about everything that has an interest rate attached to it. Moreover, as we have learned in the past year, it can also have an effect on stocks. Not just utility sector stocks, but growth stocks as well.

Term Premium is an expression which describes the amount of additional compensation a bond holder receives for taking a risk over a longer period of time. If you lend me money, you would expect to get a higher return for a longer-term loan versus a shorter one. If I promise to pay you back in 2-years, it is clearly less risky than if I promised to pay to you back in 10-years. Come on, lots can happen in 10-years, so you would want to get more compensation for taking that risk. Right? When you buy a Treasury bond you are essentially lending money to the government, so if it pays you back in 10 years you would expect to be paid a higher yield than if it promised to pay you back in 2 years. In bond language, a 10-year note should yield more than a 2-year note and that is why a normal yield curve is upward sloping. Occasionally the curve between 2-year notes and 10-year notes inverts. That means short term bonds yield more than longer ones. If you were following me up to this point, that should not make sense. But it does, in certain situations… read on.

The front end of the yield curve is closely tied to Fed policy. For example, the 2-year Treasury Note yield attempts to predict what the Fed Funds rate will be in 2 years. So, when the Fed raises rates, yields on shorter maturities like 2-year Notes and under rise, and vice versa when the Fed lowers rates. Longer maturity yields are in the hands of bond investors and traders. When bond investors expect turmoil in the economy, they rush into longer-maturity bonds as a safe haven. The increased demand pushes prices higher and yields lower. Additionally, rising yields are accentuated by expectations of higher inflation.  Higher yields must compensate for higher prices of… everything. If Fed policy is not expected to change or to get tighter, shorter-maturity yields stay constant or rise. This results in the spread between 2-year and 10-year yields narrowing, which is referred to as a curve flattening. When the Fed is at its peak obstinance in rate hiking while traders are at their peak fear level, the spread between maturities becomes negative, which is referred to as a curve inversion. This is a rare occurrence, but when it does occur, it typically happens before a recession. Check out the following chart which shows the spread between 2- and 10-year maturity notes. You can see dating back to the 1980s, that the 2/10 yield curve inverted in each of the last 6 recessions (shaded in red), including the unnatural, pandemic recession. You probably have already heard of this concept, and I know that I have written about it several times in the past few years.

It is clear that the Fed is at its height of not only restrictive policy moves, but also the height of its restrictive rhetoric, as we witnessed yesterday with the symphony of hawkish speech out of Fed officials.  Naturally, you would expect the yield curve to be getting flatter, or in this case, more inverted, and it is… er, it did. In fact, the 2/10 yield curve has not been this upside down since the early 1980s. So, what happens next? Well, it is important to note that an inverted yield curve does not cause a recession, but rather it has historically presented prior to a recession occurring. What we can say accurately, based on the yield curve is that investors are expecting tough times and that the Fed is not planning to let up on the tightening anytime soon, which in and of itself, could cause a recession. Historically, the Fed would remain restrictive until an economic calamity was imminent and then reverse course rapidly, in other words, cut interest rates. This causes the inverted yield curve to rapidly right itself and steepen. At this point, it would seem that we are not quite there yet. The Fed is clearly not ready to cut rates and bond traders remain nervous about a recession. That can only mean that the curve could invert further. Whether a more inverted yield curve portends a longer recession, you need only to consult the chart above to see that it does not. So, really what does all this mean to us. Well, for bond investors, it simply means that there are better opportunities for yield in shorter maturities right now. That may make shorter-term bonds a good place to invest idle cash while stocks sort things out with a potential recession. For stocks it means something completely different. Stock investors, who have been obsessed with interest rates for the last year and a half, may start to see the end of the interest rate hike tunnel if the Fed pivots, but there will be a new potential tunnel ahead… recession.

YESTERDAY’S MARKETS

Stocks started off on shaky legs in response to mass protests in China and news that Apple will suffer supply setbacks due to worker shortages at contract manufacturer Foxconn’s Chinese facility. China worries were made worse by hawkish Fed talk led by the hawkish hawk James Bullard who said markets were not properly factoring in potential future rate hikes. He has said this before, many times, with the same effect. The S&P500 fell by -1.54, the Dow Jones Industrial Average traded lower by -1.45%, the Nasdaq Composite erased -1.58%, and the Russell 2000 Index dropped by -2.05%. Bonds fell and 10-year Treasury Note yields were unchanged at 3.68%. Cryptos pulled back by -2.01% and Bitcoin fell -2.27%.

NEXT UP

  • FHFA House Price Index (Sept) is expected to have declined by -1.2% after falling by -0.7% in August.
  • Conference Board Consumer Confidence (Nov) may have pulled back to 100.0 from 102.5.
  • Earnings after the closing bell: Workday, Intuit, Crowdstrike, and Hewlett Packard Enterprise.

IMPORTANT DISCLOSURES.

Muriel Siebert & Co., LLC is an affiliated broker/dealer of the public holding company, Siebert Financial Corporation, which also owns Siebert AdvisorNXT, LLC. Siebert AdvisorNXT, LLC is a registered investments advisor (RIA) with the SEC and with state securities regulators. We may only transact business or render personal investment advice in states where we are registered, filed notice or otherwise excluded or exempted from registration requirements. Investment Advisor products are NOT insured by the FDIC, SIPC any federal government agency or Siebert’s parent company or affiliates.

You are being provided this Market Note for general informational purposes only. It is not intended to predict or guarantee the future performance of any security, market sector or the markets generally. This Market Note does not describe our investment services, recommendations or market timing nor does it constitute an offer to sell or any solicitation to buy. All investors are advised to conduct their own independent research before making a purchase decision. This Market Note is to provide general investment education and you are solely responsible for determining whether any investment, security or strategy, or any other product or service, is appropriate for you based on certain investment objectives and financial situation. Do not use the information contained in this email as a basis for investment decisions. You should always consult your investment advisor and tax professional regarding your investment situation before investing. The charts and graphs are obtained from sources believed to be reliable however Siebert AdvisorNXT does not warrant or guarantee the accuracy of the information. Any retransmission, dissemination or other use of this email is prohibited. If you are not the intended recipient, delete the email from your system and contact the sender. This is a market commentary, not research under FINRA Rule 2210 (b)(1)(D)(iii) and FINRA Rule 2210 (c)(7)(C).

© 2021 Siebert AdvisorNXT All rights reserved.