Signals Matters News Letter: The Signals THAT Matter
Thomas Lott, Portfolio Manager
Broadly, the core and timeless principles behind the infrastructure of Signals Matter Portfolio Construction are carefully discussed here and here.
As for WHAT’S HAPPENING NOW…
The Latest US Bond Signals:
With official CPI inflation posting 3.03% and the current yield on the 10Y UST posting 3.7%, long-term bond-holders barely avoid negative real rates/return in real time. Nothing, however, is that simple for the DC data, as we feel the official CPI is at least 50% under-reported. The Fed, in fact, measures real rates by using a projected inflation metric 13 months into the future, which gives the bond market even more of a false-positive report card.
Nevertheless, inflation is far off its 9% highs of last year, so one has to ask if Powell is winning the war on inflation. The articles linked below dig deeper into this question.
For now, and given the otherwise anemic nominal and real yields in longer duration bonds, investors are looking at shorter-duration T-Bills for greater yield in a backdrop of still persistent inflation. The 3-Month T-Bill is offering a 5.2% yield and the 2Y UST is posting 4.5%, still confirming an inverted yield curve and ever more concerns of a pending and official recession.
These recessionary concerns had previously fueled a market-signaled conviction (especially in the futures markets) that the Fed will pause rate hikes in June and eventually, even reduce rates by year-end. Such “bad news is good news” have pushed stocks up into 2023, as the market assumes/expects an eventual QE tailwind or at least rate pause for equities.
Treasuries, however, have been falling on the heels of recent and surprise rate hikes in Canada, which now have the markets wondering if Canada’s central bank knows something markets don’t—i.e., that Powell intends to keep rates steady or hiking rather than pausing or even lowering rates.
Understanding bond markets and rates is therefore a core part of understanding stock market direction, current and future.
The Latest US Stock Signals:
As for stocks, recent declines in the tech sector and concern about persistent hawkishness from the Fed have driven the broader equity markets lower. As always, so much hinges on the Fed.
Despite the notion that rising supply is supposed to push prices down, energy stocks, also buoyed by a weakening USD, saw a rise on the news that oil refineries are expanding production again. Exploration and equipment & services shares in this space saw large gains, which Signals Matter has captured.
Banks (and hence financial stocks) in the US face new challenges. Having already suffered the declining price value of their underlying UST collateral due to Powell’s rate hikes, those same rate hikes have also led to higher corporate debt expenses and (along with shifting, post-COVID work policies) higher vacancy rates in the commercial real estate sector.
The risk of non-performing loans in this corner of the real estate market can add even more stress to an already struggling banking sector, whose post-SVB gains have been lost as some 700 US banks are now exceeding their loan concentration guidance.
Other Key Market Signals:
This week the World Bank continued to warn of a “precarious situation” in the global economy as rising debt levels continue to collide with rising interest rate costs. The Fed’s battle against inflation is by no means over, prompting former vice-Chair, Richard Clarida to claim that the Fed will likely NOT be cutting rates until at least 2024.
We shall see.
Despite such debt and rate concerns, the MSCI All World Indexes are believed to have bottomed and have since reached a 12-month high which the markets explain as a part of inevitable re-valuation upwards coming out of the pandemic bottoms.
Emerging Market securities are giving interesting signals. Their stocks have been rising at a relatively higher pace coming out of the pandemic, but the higher yields typical to their sovereign bonds, which are critical to attracting investors seeking any kind of yield, have been falling to March levels.
Once again, the shifts and confusion still seem to hinge on what Powell does (or does not) do with regard to interest rates. Those betting on a rate pause are also expecting more IMF loans to the emerging markets. Foreign inflows into India, moreover have been a key force in their fastest growth rates.
The important question is what really drives such inflows? Is it speculating on the interest rate moves of the world reserve currency, or are such inflows indicative of a growing move toward the BRICS as their collective share of global GDP surpasses that of the G-7?
Maybe there’s more to the EM markets than just speculating on Fed hikes?
Even More
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