How Long Can This Go On?
Apart from the U.S. human headline there are not many market discussion points other than a continuum of affronts, conspiracy theories, and a Congress that is rapidly tiring of the Trump Presidency. Congress at this stage appears to be pushing back on the thinly crafted budget and tiring of the Trump claim of being bugged. There was however a small win gained over the weekend by Mnuchin where the G20 Finance Ministers agreed to not put protectionism in their Agreement. The specifications for the Wall have now been released and prototypes are being asked to be presented in San Diego shortly. Where the funding for the Wall will come from is still being decided but it appears as though a social programme will be cut to help pay for the Wall. Mexico remains defiant and has no intention for paying for the Wall.
The real market conundrum is the bond market. Bonds are now looking to rally a little after spiking to 2.60%. What is interesting is that bonds have traded in a 34 point range since December and has failed during that period to break significantly one way or the other. Whilst short term rising rates are indicative of a healthy economy, and an increasing inflation rate, a falling long term bond rate generally indicates economic health issues. The bond market has currently stalled and there appears to be some concerns over the health of the U.S. economy moving forward a year or two. Perhaps the allure of Trump, his petulance, lack of detail and conspiracy theories are jading investors.
Of deep concern is where do markets now move? A little while ago bonds were trading sub 1.90% and the average dividend of an S&P 500 stock was 1.90% (according to Fact Sheet). This made the decision to purchase dividend paying stock easy and investors bought bonds for capital gain. The Merton Model and the Dividend Discount Model and other models then suggested that equities should be higher. Also driving prices higher were investors’ preference to purchase equities paying good dividends. Hence this is probably the reason why equities have been so strong for a while.
We are now at the stage where bond rates are higher than equities and buying equities for dividends is no longer a preference. The rational investor preference now becomes relevant. Where we go from here now becomes a function of expectations. If investors believe in one or two more rate hikes before the Fed either starts to stall or ease then equities are close to a top. A number of forecasters have rates moving higher till 2019 before the Fed starts to ease in 2020. These forecasts have investors a little concerned and as such this is why Trump’s behavior is so important. Markets are fickle beasts and are full of raw emotion and confidence. A loss of confidence would be disastrous. To date we have a Budget that many Republicans are questioning and baulking at, we have relatively scant detail on trade policies and it appears as though the U.S. is intent on bullying its best supporters. Many of Trump’s acolytes appear to have little understanding of trade negotiations and who is responsible. For example Trump acolytes wanting to deal with Merkel’s team direct on trade when they should be dealing with the EU, or for that matter the complaints that Germany is doing well versus the U.S. Germany does not have its own currency so to label Germany a currency manipulator shows little understanding. Germany manufactures goods of high quality and has a strong engineering culture, and that’s why German goods are in demand. Trade policy will play an important part moving forward, and that’s what could really upset markets if trade were to break down.
On the Friday bonds were a tad stronger.Equities fell marginally down 0.1%. The Vix fell 7.5% the lowest since November 2014 and is trading around 11.28. There is no fear alternatively options traders are covering shorts or putting on butterfly’s. The Dollar index fell 0.1% mirroring equities. West Texas Intermediate gained about 0.1% to settle around 48.78%. The yield on the U.S. Treasury yield fell 4 bp to close around 2.50%. Bunds rallied 1 bp to finish 0.43%. The 2/30 are trading at 179 and the 2/10 are trading at 118. The curves are flattening.
Aussie Market Today.
U.S. bonds were a little better on the day and equities were a little weaker on a day where volumes remain low. The Aussie Market should see bonds stage a rally and the equity market could struggle on the day. However I expect that equities could rally a little. Iron ore is steady at around $89, however the good news is that Chinese property has started to perk up and is strengthening. This should create demand for steel and raw materials such as iron ore, coal, copper aluminum and other basic building materials. China is starting to grow again and this bodes well for the Australian Resource sector and housing sector as demand increases.