One of the major concerns investors had to worry about last year was the inverted yield curve. There are many studies and historical precedence, but typically when you have long rates lower than short rates, it precedes an economic recession by 9-18 months. Once the curve inverts, with the standard metric being 10-year Treasury yield above the 2-year Treasury yield, the stock market usually continues to advance for about a year. Then GDP turns negative. This latest inversion occurred in the summer of 2019. That would lead some to believe growth will stop in the summer and the stock market should peak soon. As an aside, an inverted yield curve hasn’t happen enough times to make it “statistically significant” but it has a great track record. It does bear watching.
The conclusion makes perfect sense. As we’ve seen with the Fed Balance sheet expansion and ultra-low interest rates, when capital is cheap and banks are willing to lend, investment occurs. The stock market loves it. When a bank borrows at a higher rate than it can lend at, they stop making loans. Money supply contracts and GDP slows. Banks aren’t going to borrow at 5% and lend money at 4% no matter how good your credit is.
However, this latest inversion did not last long. Most inversions last several months while the Fed reverses course and cuts rates. This is accompanied by some sort of a bubble, usually in commodities. Recent memory shows a multi-month inversion that started during the rapid housing expansion in 2006, Y2K over investment in 1998 and multiple times in the inflationary ‘70’s. These were all just before terrible periods for the stock market. The average inversion was 14 months. This inversion didn’t even make it a full month. Score one for the bulls. Further, most bank earnings reports this year have shown solid loan growth. The inversion didn’t impact lending to any extent in 2019.
The most important leading indicators one can watch to make sure this inversion won’t lead to a true recession are employment statistics. When employment numbers worsen, you can be sure corporations are seeing something in the pipeline that is a cause for concern. The US consumer still accounts for ~70% of GDP and has been the key driver of spending. There are many data sets to view.
There are inklings that the best may be behind us. The JOLTS report (Job Openings and Labor Turnover Survey) fell the most in nearly 5 years according to this week’s release. Job openings fell by 561,000 to 6.8 million. This is the third largest monthly drop since 2000 and is two standard deviations from the norm. Construction was down 112k, manufacturing down 59k and retail down 139k. One month does not make a trend and can be an outlier with the China trade truce coming after this report. It does bear watching. If unemployment numbers worsen from here, raising some cash would be recommended.
On the other hand, yesterday’s unemployment claims data was solid. Upcoming reports should show if this was an aberration or the start of something else. As Jim has pointed out, there are many reasons to be optimistic with global central bank easing, fed balance sheet expansion, rebounding economies, low commodity prices, a muted DC and some semblance of a trade war easing that should lead to top-line corporate revenue expansion. So long as the consumer is seeing stable wage gains and is fully employed, this will be the first inversion to not lead to a recession dating back to 1950. We’re not out of the woods yet, but most signs are pointing to a positive outcome.
On the earnings front, most company’s 4th quarter reports are coming in ahead of lowered estimates. There isn’t much top-line growth to write home about outside of Technology and Consumer sectors but stabilization is occurring in key industrial sectors. The next stage is expansion. How much good news is priced in will determine the trajectory of stock prices.
For instance, Texas Instruments# reported sales that were down 10% for calendar 2019 but the stock advanced 35% during the year! Much of the rebound in expected 2020 growth is likely priced in. It will take solid beats to make the stock run higher from these levels.
Old school technology is even performing well now. Two companies that used to be bellwethers for their industry but have lagged over the years reported this week, namely IBM# and Intel#. Both reported better than expected on the top line with some margin improvement flowing down the earnings per share. Their stocks reacted positively and are well ahead of the major indices.
One quarter does not make a year, but turning these behemoths around takes time. It is difficult to completely change a large company overnight. Combined, these two have nearly $150B in revenues. Microsoft took many years before they transformed into a cloud host. Oracle acquired numerous cloud companies before growth resumed. Intel makes more money from servers, Internet of Things and Data Centers than PC’s now. They have a leading automotive platform from the MobilEye acquisition. IBM closed their largest deal ever with the purchase of Red Hat and are attempting to be a hybrid cloud leader after missing out on the first phase of cloud hosting. Again, they need to consistently prove they can grow, but valuations are well below the industry and the dividend yields are safe. It’s tough to say that about most technology companies today.
American Express, Synchrony Financial# and Capital One all had solid earnings results this week as well. The US consumer continues to be willing to load up on cheap debt during the Holiday season. This can be great for GDP but one must monitor debt levels. Weakness in auto loan payment metrics has been ongoing. If that extends into credit cards, there will be more to worry about.
Today, actor Ed Helms is 46 and Neil Diamond turns 79.
James Vogt, 610-260-2214