The drugs must be wearing off and my need for Ritalin has escalated as my thoughts waver. Einstein famously declared that the definition of insanity is doing the same thing but expecting a different outcome. And, alas, that’s what I am thinking.
Markets rallied today, not because economic growth was surging or that something fantastic was happening. But rather because inflation remains subdued and that means the Fed won’t be tightening too quickly and possibly only tighten twice. This means no tweaking to my dividend discount model. However, a twerk or two may happen. So once again the driver for all things markets was the Fed not doing anything. What was I thinking?
The yield curve is now the flattest it has been since 2007. The 30-year rallied because fears about inflation have dissipated. And those fears must most assuredly have evaporated as the 30-year sized auction was a record at $17 bio.
The bull flattening should not, however, precipitate a rally in equities as lack of fear over inflation suggests there is something fundamentally wrong with the economy. And that’s not so good for equities. The yield curve flattened to 13.1 for the 5/10 and 27.7 for the 5/30’s.
The belief that the Fed will tighten in June, but will take longer to hike next time, is driving the curve in addition to inflation fears dissipating for the moment. A slowing economy will have to deal with increased issuance to meet budgetary needs.
So, what is driving equities as equities are in a very interesting space? The big driver, of course, has to do with share buybacks and borrowing at very attractive low rates to provide higher dividends, thus pushing prices higher as demand for high dividend paying stocks increase. This is illusory but can continue as long as there is plenty of free cash which there is at present. But that pile is slowly dwindling.
Equities received their boost from the Trump tax cuts. For the last 12 months, S&P firms are on track to deliver $1 tr to shareholders by way of buybacks and dividends. Over the last 3 months, as reported, some 85% of S&P 500 companies have bought back $158 bio of their own stock. That’s why the equity market keeps rallying.
The signal to watch for is when liquidity dries up. For the S&P firms that spent the most on buybacks, about 75% outperformed the index. The group has risen some 5.2% compared to a 1.9% rise in the index. For example, Apple announced a $100 bio buyback. Its shares increased 4.4% the following day and 13% for the week, the biggest percentage gain since 2011.
This is the problem for the U.S. economy. Money that is supposed to go back into the economy and drive economic expansion is going into relatively few deep pockets that are not investing in the economic expansion of the U.S.
For the middle class, this is a disaster as it does not lead to jobs creation, growth or better jobs. For companies not spending money on capex, this only allows the competitors such as China to catch up or surpass the U.S. Many U.S. companies are heading towards extinction because they are not seeking to boost productivity nor are they spending on capex.
For the moment, with a large cash pile, companies can pick off unicorns. However, whilst that generates M&A fees for banks, it does not necessarily generate the desired outcome. The recent tie up between Wholefoods Market and Amazon comes to mind. Without the support of buybacks, the equity market would be in a different space.
The Dow rallied about 0.8% on the day. Of the 11 major sectors within the S&P, all posted gains. For the moment, the equity market has forgotten about heightened geopolitical risk in the Middle East and a trade war with China. The market has reclaimed its 100-day moving average and as such some traders are looking for a move on the upside. The S&P posted 37 new 52-week highs.
Equities: The S&P 500 closed up 0.9% The Dow rose 0.8%. The Stoxx fell 0.1%.
Currencies: The Bloomberg Dollar Index fell 0.7%. The euro surged 0.6%.
Bonds: The ten-year closed around at 2.964%. The 2-year closed at 2.534% and the 30-year closed at 3.109%. The ten-year bund closed at 0.555% and the UK gilt closed at 1.43% and the OAT closed at 0.797%.
The U.S. curve closed the day with the following closes 2/10 at 42.8 bp, 2/30 at 57.4 bp and the 10/30, closed at 14.4 bp. The U.S. 5-year closed at 2.83%.
Commodities: WTI rose 0.3%. Gold rose 0.6% and copper rose 1.8%.
Bitcoin is trading around $9,099.
Aussie Market Today.
The Aussie market should see equities continue to rally despite increasing geopolitical risks. Bonds will probably surge on the day as the outlook looks more positive if U.S. bonds continue to rally.
Some book squaring may occur but that is more likely to drive prices higher as most traders appear to be on the short side.
Aussie to be stronger on the back of a weaker U.S. dollar.