Jim Cramer mentioned the term "bond vigilantes" in his piece on Thursday afternoon. It had been a while since I had heard the term, so long in fact that I doubt very many of these bond vigilantes are those bond vigilantes. Equity markets sure could use an appearance by the late Dan Dorfman on CNN right about now. One thing is certain, however. That is, in case we needed to be reminded, the bond market is still the dog and equities are still the tail.
Oh, maybe two things are certain, and the second of these two could scare a few folks. That is the fact that even though free market pricing of credit over time can be skewed by monetary policy, and skewed for great lengths of time, that the bond market itself can revoke that control and reassert its own control over interest rates should said monetary policy become forced, or should it become perhaps an inappropriate fit for the current environment.
In other words, central bankers can force their will upon debt markets, but debt markets can also force central bankers to bend their will. Will they? We as traders might complain as easy money becomes more difficult to make, but the fact is that there is a chance, perhaps more than a real chance, that the free-market flexing of these muscles will indeed end up being a good thing.
The thing we do not know is how this all turns out. How will the Federal Open Market Committee (FOMC) or other global central banks respond to this changing environment? We have spoken of the tipping point for equities. Where is that spot? Is it here? At year's end the dividend yield for the S&P 500 was 1.55%. At the equity market's mid-February highs, even with a few increases, this dividend yield had dropped to 1.48%. On Thursday, as Treasury yields spiked across the entire curve, the most focused upon, that of the U.S. 10-Year Note, breached both the 1.48% and 1.55% levels before hitting support (yes, support; remember, new kids, yields move inverse to price, so support is resistance and vice versa).
Psst... you were never supposed to make money in stocks without considering corporate balance sheets in the first place. I would cautiously welcome the return of a more difficult environment, not because I like being wrong more often, but I think it eventually (quickly) separates those who do put in the extra hours of homework from those who do not.
Look the word up. In English the word is the name of a genus of very small sea snails or mollusks. So small, you would probably not notice the shells should you walk past hundreds of them on the beach. In Latin, the word means a closed hand, or a fist, hence the root of the word pugilism, now used as another word for boxing.
Ever been hurt by a small sea snail? Probably not. Ever been hit by a real pugilist? Chances are that, if you were, and that boxer was the real thing, that you were hit twice before you knew it and figured out what happened after it already had. That's what happened to equity markets on Thursday.
Markets were coming off of a strong session on Wednesday, but admittedly a strong session that we warned here was not supported by strong trading volume. Equity index futures were showing signs of weakness. Then the numbers hit the tape. Weekly initial jobless claims printed at 730,000, down from 841,000 a week ago and versus expectations in the 830,000s. Continuing jobless claims also printed lower, at 4.419 million, down from 4.52 million last week. The federal government's Pandemic Unemployment Assistance program that targets sole proprietors and gig workers not eligible for state level jobless benefits saw the rolls (unadjusted) drop from 513,000 to 451,000. There appears to be a sudden improvement in labor markets corresponding with the recent success of the vaccines in slowing the spread of Covid-19.
There's more. Forget about the slight upward revision to fourth-quarter GDP. Yes, it's nice, but meaningless in real-time. Durable Goods Orders for January ripped the cover off of the ball at headline month-over-month growth of 3.4%, the most aggressive print in this space in six months, and well above the 1.2% growth that economists were broadly looking for. Strip out transportation purchases? OK, still up 1.4% month over month versus consensus of 0.7%. Strip out the military? OK, still up 2.3% month over month versus the paltry 0.3% that Wall Street in all of its wisdom saw coming.
The reality? Businesses invested in themselves in January, and labor market conditions might be improving earlier than we thought. I say 'might" because these numbers do include wild weather conditions for much of the country and a federal holiday, so we do need confirmation next week. Still, if businesses are ramping up, one would think that demand for labor would be part of it. That was just a left jab.
The Right Cross
After equity markets had been jabbed with positive-looking domestic macroeconomic data and stood there already considerably lower for the day, somewhat stunned, the pugilist laid out the victim with a powerful right cross.
The United States Treasury brought $62 billion of seven-year notes to market early on Thursday afternoon. You do not need bond vigilantes making sales in the secondary market to put the whammy on debt and subsequently all financial markets. Sometimes it just takes a lack of demand for paper. Face it: $62 billion is a lot of dough, and the bid side just never showed up, not in its usual size or with its usual appetite, anyway. The yield awarded at auction was 1.195%, The bid to cover? Just 2.04. Participation by foreign investors (central banks) -- aka, "Indirect Bidders" -- came to a mere 37.9% as that group collectively took down a mere $23.592 billion of the $62 billion sold.
For the sake of comparison. a month ago, on Jan. 28, Treasury also auctioned $62 billion of seven-year paper. That day, with a much lower yield awarded (0.754%), bid to cover landed at a closer-to-normal 2.3 and Indirect Bidders took down $39.738 billion of the $62 billion sold, much closer-to-normal "foreign interest" at 64% of the entire offering. Just as equity markets entered that part of the day where the algorithms had been trying for several days running to rally prices off of their lows, the "two" punch had landed. There would be no "day's end" equity market rally on Thursday.
Of all the major and sub-major equity indices that I mention in my morning notes, the Dow Jones Industrial Average was Thursday's "out-performer" at -1.75%. Both the Nasdaq Composite and Nasdaq 100 gave up more than 3.5% and the Russell 2000 took the worst beating of all at -3.7%. All 11 S&P sectors closed in the red, with 10 of the 11 closing at least 1% lower for the day. The four top-performing sectors were all defensive in nature... in order, Utilities, Health Care, Staples and the REITs.
Breadth was close to as awful as it gets. Losers beat winners by almost 7 to 1 at the New York Stock Exchange and by more than 7 to 1 at the Nasdaq. Declining volume beat advancing volume by 11 to 2 at the NYSE and by more than 5 to 1 at the Nasdaq.
Aggregate trading volume increased day over day by a significant enough degree for listings of both exchanges. This does imply increased professional distribution. There is a bright spot, however, where some of the worst beatings have occurred this week. Aggregate trading volume across constituent names for the Nasdaq Composite, even with a day-over-day increase, still fell 7% short of its own trading volume 50-day simple moving average (SMA) and has failed to reach that mark for three of the four trading sessions this week. This is not true of the S&P 500.
Does this mean that while there has undeniably been a broad distribution underway, that for those most exposed to the tech sector or to industry groups labeled as "growth" that there is something of a "deer in the headlights" effect going on? Or perhaps not everyone is convinced. This could mean that the larger sell-off is still to come, or it could just mean that much of the negative price discovery across these groups has been the result of a "buyers' strike" as much as a forced reduction in exposure to risk.
I don't know anything for sure. I do know that there has been no capitulation. I do know that the Fed meets on March 17 (Erin Go Bragh) and that futures markets are still not pricing in any change in probabilities for a retargeting of the fed funds rate that day. I have been a net buyer at or close to the lows of the day (which for me runs until 8 p.m.) for a wide swath of my favorite names in these groups for three consecutive days. House money? To a degree. Every time I buy more on these dips, I do significantly increase my net basis, so I could have just sat on my hands and performed better in percentage terms, but it is U.S. dollars that feed my family, not fancy-looking performance. Does that mean that I'm brave? I have always been brave. Does that mean I'm smart? Not at all. That said, the Nasdaq Composite surrendered the 50-day SMA on Thursday, and if not quickly retaken, those reluctant portfolio managers mentioned above will start being pushed around by their risk managers. Perhaps that's what we need.
What Does the Fed Do Now?
First off, those on the committee must appear committed to regaining full employment. With an economic rebirth, and very likely, greatly expanded deficit spending on the way, there comes vast liquidity and probably increased velocity. It is this velocity in that environment that will produce the consumer-level inflation that many fear and the central bank, not to mention the U.S. Treasury Department, crave. Their first option will be to keep on doing what they are doing, which is to pin the short end of the Treasury yield curve as close to zero as possible, while permitting the long end to flap around at the mercy of free market pricing.
Now, in this algorithmic age, prices move very quickly. This is a six-month chart tracking U.S. 10-year note yields... February has been a real doozy.
This is the same time frame but tracking the spread between the 90-day paper yields versus that 10-year note....
... and this is that same time frame tracking the above yield spread with an overlay of the Dow Jones U.S. Banks index.
If you fear higher interest rates or feel that you are not properly diversified, increased exposure to U.S. banks (because they are in better shape than foreign banks) is one way to shield thyself from this fallout.
Now, if the Fed believes that monetary conditions (not monetary policy) are tightening on their own too quickly, and this slows both the recovery in labor markets and the velocity of money, it will take action not only to increase the $80 billion ($120 billion) in U.S. Treasuries (UST+MBS, or mortgage-backed securities) purchased every month (because once you're in, you're all in) and do so in a way that extends the average maturity of the Fed's balance sheet. The Fed might even try another round of "Operation Twist" despite the attempt by the Ben Bernanke-led Fed in 2011 to stimulate the economy by using funds provided by maturing short-end securities and buying the long end of the Treasury curve with the proceeds.
Was that "Operation Twist" successful? It was successful in suppressing long-term interest rates. It was not successful in stimulating an economic recovery that felt more like a prolonged recession at the time for lower- to middle-class Americans. Suppressed interest rates at that time really only served to slow velocity and suppress wages. Is that what we want? Maybe they throw out of the universe of economists for this, but maybe we give the free markets a chance to find a level? Maybe the correct path is one where all goods and services to include credit over time have a price determined by the unskewed forces of demand and supply?
You and I both know that pure free market pricing would be best in the long run, but that there would be pain to be paid up front. Hence, we will never know. We will borrow more and more, and pay less than we should to do so. That is how it shall be until there is a loss of confidence in fiat. By then, the National League will have long adopted the DH Rule, and all that is decent and pure, permanently scarred.
Economics (All Times Eastern)
08:30 - Personal Income (February): Expecting 9.7% m/m, Last 0.6% m/m.
08:30 - Consumer Spending (February): Expecting 1.8% m/m, Last -0.2% m/m.
08:30 - PCE Price Index (February): Expecting 1.5% y/y, Last 1.3% y/y.
08:30 - Core PCE Price Index (February): Expecting 1.4% y/y, Last 1.5% y/y.
08:30 - Wholesale Inventories (Jan-adv): Expecting 0.2% m/m, Last 0.3% m/m.
08:30 - Goods Trade Balance (Jan-adv): Expecting $-83B, Last $-82.47B.
09:45 - Chicago PMI (Feb): Expecting 61.0, Last 63.8.
10:00 - U of M Consumer Sentiment (Feb-F): Flashed 76.2.
13:00 - Baker Hughes Oil Rig Count (Weekly): Last 305.
The Fed (All Times Eastern)
No public appearances scheduled.
Today's Earnings Highlights (Consensus EPS Expectations)