I am writing this on the afternoon of November 20, 2018. The stock market is really bad. Apple, Inc., the star of the show, lost almost 5% of its value today and is now at $177 and in Bear Territory, down about 23% from its high of just over $230. The Nasdaq 100 Index likewise is down 15% from its high, reached just 8 weeks ago. Tech is getting wrecked. Crude Oil declined for 10 straight days earlier this month, recovered a bit, but fell today by almost 7% to its lowest price in a year, dragging energy-related stocks along with it. Non-Tech and non-energy related stocks are also getting hit: The S&P 500 is down 10%. The meme out there is that investors are concerned about future economic growth, trade uncertainty, and interest rates. Is the shoe dropping?
2/10 Spread
Another way that looming troubles manifest themselves is in the bond market. The Federal Reserve has been raising short-term rates for a couple of years, and have raised the Fed Funds rate about 225 basis points, or 2.25%. The problem is that longer-term rates have not risen commensurate with short-term rates. As a result, the spread between the 2 year and 10 year US Treasury yields has narrowed again in recent days. According to Bloomberg, the current spread is only 26 basis points (2.80% for the 2-Year and 3.06% for the 10-Year). This is 3 basis points narrower than it was 1 month ago, and lower by 13 basis points for the 10-Year yield. Investors are selling stock and buying these US Treasury bonds, forcing prices up and yields down.
Tone-Deaf Fed
The Fed, particularly Fed Chief Jerome Powell, is catching heat in the media for its “tone-deaf” statement coming out of its most recent meeting a couple of weeks ago. Powell’s statement was to the effect that the economy is rosy and there is no reason to re-visit the current policy of raising interest rates. Another Fed rate hike in December seems to be highly likely. The criticism is that things really aren’t that rosy, particularly in other parts of the world, and that corporate inventory build-up and other factors are pointing to an increased threat of recession that the Fed seems oblivious to.
The Powell Put
I believe these stock and bond market changes will cause the Fed to change its tune somewhat when it meets in December. I believe the Fed will raise rates in December but will state that it will re-look at any future rate raises as economic data becomes available. The Fed never reverses course: It will pause whatever it is doing, take a look around, and then decide to move forward or backward. The Fed is a supertanker, a large entity that is piloted slowly, but with huge ramifications. When (and if) the Fed and Chairman Powell state that they are no longer planning to increase rates further, the stock and bond markets will rejoice. That doesn’t mean things are going straight up after that, but changing a future pattern of rising interest rates would take away one big fear that investors currently have. This is the “Powell Put”: that the Fed will say they will no longer increase rates, causing an end to the downside in stock prices. At least that’s what stock investors hope will happen.
IMO
This doesn’t mean that I think you should buy stocks now. The knife could fall further between now and mid-December when the Fed meets again, and the Fed might not say what I think they will. Also, as you know, my advice is worth what you pay for it. Nevertheless, I have written before that the Fed will not continue to raise rates into an inverted yield curve and a recession, and I think we are approaching an inflection point now and that the Fed will stop, look around, and change its course on interest rate increases.