It’s been exactly three months since the U.S. Federal Reserve raised interest rates from zero. A lot has happened since then in global financial markets, but looking at the year to date performance of some key markets you wouldn’t know it. The S&P 500 (SPX) is down only 1.37% on the year, the yield on the 10 year treasury is back at 2%, the high yield index (HYG) is up 1.7% on the year, crude oil is essentially flat and the U.S. dollar index (DXY) is actually down nearly 2% . I’m not really sure why, but the sources of market tension in Jan and Feb turned on a dime, and it all just feels like a bad dream that came and went.
This may shock you, but I have a slightly different take. Monday in this space I highlighted my views from a technical standpoint (MorningWord 3/14/16: VW Bugs). The recent equity strength still looks like a sharp counter-trend rally, with most major U.S. equity markets remaining in downtrends. And the SPX has done something of late that it has not done throughout the entire bull market off of the 2009 lows, made a new lower low below the long term uptrend.
After years of the SPX not making a lower low during its 200 plus percent rally off of its 2009 lows, it finally did so in November, and a failure below 2116 (the Nov 2015 high and still some 96 points or 5% higher than current levels) would still mean that the SPX is in a downtrend. This combination of the lower highs, and lowers lows, and three 10% or more selloffs since the end of QE and ZIRP is new and not bullish in my opinion. I would not change my intermediate term cautious view on U.S. Stocks until the market put in a close above 2100:
Turning elsewhere from the SPX and its mere 1.4% ytd decline things don’t look as calm. Remember that gold is up 16% year to date and global equities remain deep in the red. The German DAX is down nearly 8%, the Euro Stoxx Bank index is down 18%, the Japanese Nikkei is down 11%, the Shanghai Composite is down 19%, small cap stocks in the U.S. measured by the Russell 2000 are down 6% and down 17.6% from its all time highs made last June.
But here may be the most significant. Despite the end of QE & ZIRP, the yield on the 10 year Treasury remains at 2%, down 35% from its 2014 high of 3%, down 45% from its 2011 high of 3.6%, down nearly 65% from its 2007 high of 5.3% and down 70% from its 2000 high near 7%. Since the dotcom collapse, U.S. Monetary policy in the U.S. has been consistent, and producing ever declining Treasury yields. That policy has been inflating and then destroying massive risk asset bubbles for some time:
In the last ten years we have seen a real estate bubble in the U.S. and a commodity super-cycle in the aftermath of the great financial crisis. These were only possible with the collapse in the U.S. dollar and declining U.S. Treasury yields.
So when I wonder about what the Federal Reserve will do and say today I know they have few good options. If they raise rates again and strike too hawkish of a tone they run the risk of a similar risk asset rout and capital flight from emerging markets that were at the heart of the Jan/Feb volatility. If they are too dovish, too focused on weak global growth and the potential for it to weigh on ours, they run the risk of scaring global investors in the near term while keeping rates too low for too long and reflating a risk asset bubble in the long term, as was the case after the mid September FOMC meeting. I am not exactly sure what the middle road is, as they risk losing whatever credibility they have left. It’s my view that investors need a little reset, a reminder of what are the risks of owning risk assets in a very uncertain global economy that has been kept on life support by central banks money printing. I am far from sure that the two W bottoms (Aug/Sept & Jan/Feb) did the trick to work off over exuberant risk taking. If the SPX had two 50% peak to trough declines in the last 16 years, a period with unprecedented accommodative monetary and fiscal policy, there is really no reason why it can’t happen again. Especially, as my friend Guy Adami says, central banks have painted themselves in to a corner that is becoming increasingly small.