Monday, April 16, 2018

Economically Speaking - Part 1

There has been a lot going on lately and for the benefit of my and hopefully you, I'm going to get my thoughts down. It's like bumper cars in my brain right now and I hope to get this sh..tuff more organized. Almost daily, something new will come to the foreground command my attention. I wake and wonder what I will unintentionally focus on today. Will it be: trade wars, war wars, unemployment, interest rates, inflation, the yield curve, quantitative easing, GDP growth, cryptocurrency being get the picture.

In no particular order, here are my own opinions on the things we have been hearing. As always, from an Uninformed Investors point of view.

I've decided to make this a multi part post. It would be too long to put it all here and I did not use my time wisely and the things I wrote about earnings pertain to events today [4/16] that should be posted today. So, Part 1!

Yield Curve

The spread between the short term and the long term yields are thinning. At this point it isn't any cause for concern, more so just something I'm keeping in the back of my mind. Why is this important? Every recession has been preceded by a negative spread between the 10 year treasury and 2 year treasury yields. The average time is about 18 months, or a year an a half.

Typically, the yield curve is upward sloping. Why? When it comes to investing money in bonds, one of the biggest risks is time. A dollar today is worth more than a dollar tomorrow because you can invest that dollar. The longer you're expected to put your money away, the higher return and the more money you expect to get in the future. Therefore, the yield on a 10-year bond will normally be higher than the yield on a 2-year bond. There are more risks associated with putting money away for a longer term. Could be interest rate risk, could be inflationary risk, could be liquidity risk.

When I say the spread is thinning, I mean that the rate of return between the 10 and 2 year are becoming closer together. Investors are becoming worried [allegedly] that yields will remain where they are now or go lower in the future. The demand for the 10 year is increasing, driving bond prices up, and yields down. Thus, the demand for the 2 year is decreasing, driving bond prices lower and yields higher. Generally.

When the yield curve inverts and the short term return is great than the long term the economic sentiment is usually negative. Actually, nearly always negative. The future is always unknown, but sentiment is a big driver. As I write, the spread is about 0.50%; the smallest it's been since 2007.

The chart I have goes back to 1976. There have been 5 recessions since then, as marked by the grey bars. Each recession is preceded - by about 18 months - an inverted yield curve. The spread has been trending down since the end of 2013 but is still positive.

Something I am watching, but not something that will dictate my investment decisions. Yet.

Earnings Expectations

I am torn on this one. The overall expectations are that earnings are going to be great. This next month are primarily quarter 1 reports. That means firms will start to notice the tax rate differential and hopefully project higher earnings estimates. In fact, this earnings season started just last Friday with some major banks, Wells Fargo, JPMorgan Chase, and Citigroup to name a few, reporting [mostly] better than expected results. The kicker? The stock prices fell in the whole financial sector.

I honestly don't have an explanation. I'm sure there is one, but in my head I haven't figured it out. With interest rates going up and lending banks being able to secure higher lending rates, and the volatility of the markets causing panic and wreaking havoc thus increasing the bottom lines for trading focused banks, the outlook looks good. Rates are expected to keep rising and market volatility historically stays that way for the year.

Yet they went down. The ETF that tracks the financial sector, XLF, fell almost 1.50% Friday after increasing about 1.80% on Thursday in anticipation of good news. Could it have fallen because of all the other breaking news on Friday? Possibly. But why would the rest of the S&P500 be relatively flat?

I do not know. I don't have an answer for myself yet so I can't really write anything down.

Staying with earnings, I want to talk about Netflix. They report after market close on Monday. After reading Barron's this weekend and seeing multiple analysts raise targets on optimism and beating consensus EPS I am a little worried.

It can be a huge boost for tech and for earnings outlook if Netflix does perform well. Assuming they do what everyone expects and projects higher than anticipated revenue and earnings, it could act as a precursor to other tech and help to boost the market. Get the bull market back on track after a choppy first quarter.

I'm worried because of the all around optimism presented here. There are a number of market crippling factors within arms reach which are being completely ignored for the idea that the glass is half full. In this regard, I do think that earnings will be rosy and it will help the market chug along; producing higher highs and higher lows. But not for long. Some think that after this earnings season we will see market level near the January 26th high. I do not.

There is too much else going on that will slow momentum. Tariffs and missiles and tweeting and debt and I'm sure a bevy of other things. This is a picture I came across today that stuck with me. Where are we right now?


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