No, we shouldn’t be. Not yet at least.
Granted this whole issue does have our attention now, given that “fear” and “turmoil” were the words used to describe markets this last week. However, I believe the game has changed since the subprime financial crisis, and I’ll get into that shortly.
But first let’s get right into the action: The Dow sank 3.1% on Wednesday, along with the S&P 500 dropping 2.9%. The Straits Times Index hit 3084. The Hang Seng Index has dropped for a fourth straight week and briefly fell below 25,000 for the first time since end 2018. China, Germany, and Italy have all reported poor economic data, and of course, the most critical element in all of this, the U.S. and U.K. Yield curves inverted.
2y10y Yield Curve Inversion: Why It Matters
The yield curve we are talking about looks at the 2-year and 10-year treasury notes of any government’s bonds. Why? That’s because it is a gauge of investor sentiment and also critical to the model of banking. If investors are bullish on the long-term outlook, the 10-year term premium will be greater than the 2-year premium since investors expect to be compensated according to the greater risk they face when holding a longer-term bond.
When the yield curve inverts, it means investors expect greater compensation for shorter-term bonds than they do for longer-term bonds. US 30-year bond yields have also dropped significantly and this shows that there is a flight to bonds by investors. Throw in a Gold rally and a clearly strengthening Japanese Yen, and we are definitely in Risk-Off mode now.
A yield curve inversion is also critical to banks. Banks lend long-term and thus earn on longer-term rates while paying out on deposits on short-term rates. Therefore, a bank’s profitability will be crimped by a yield curve inversion. If the yield curve stays inverted for an extended period, expect bank lending to slow significantly.
Singapore: Don’t worry, we’ve been here before, from 2011 to 2012.
Yes, Singapore’s NODX (Non-oil domestic exports) data is down, and most recently dropped 11.2% in July. Add in a bleak GDP outlook from MTI, and it seems like we’re headed for rougher times ahead. Singapore Markets reflect that sentiment. But if memory serves, we’ve seen this before, sometime between 2011 and 2012. Just look at this article from SBR in 2012. Let’s also look at some of our own economic data, from NODX to Unemployment.
As you can see from the NODX data above, we’re not really in dire straits. We’ve seen worse NODX data along the way since the end of the subprime crisis in March 2009.
The same goes for our manufacturing PMI. Nothing too much to worry about just yet.
Lastly, our unemployment rate looks pretty decent given the current issues surrounding our economy. Of course, unemployment might go up slightly as a result of the economic headwinds but unless it really starts to tick up towards levels not seen since 2009, we don’t need to be too concerned.
U.S. : The economy is healthy but Trump wants his big rate cut.
As per my previous article on “Trump and The Orchestrated Market Boom”, I mentioned that the FED had no business cutting rates. The anticipated slowdown is mostly artificial as a result of the trade war, and Trump’s desire for a more substantial rate cut. 3 days after I published my article theorising what Trump was really up to, he states his intentions loud and clear; Trump wants a bigger rate cut from the FED. Hence, nothing really changes the U.S. outlook at the moment. The US Economy is healthy and slowly improving or at the very least reaching steady state. Only until we see economic data and corporate earnings sliding drastically do we need to worry.
Eurozone: Germany and Italy, basically more of the same.
Italy has far more serious issues that run deep, beyond simple economic numbers. Italy has had nearly 20 years of non-existent economic growth, and are facing a demographic crisis with an ageing population. They are also facing an erosion of their cultural heritage and immigration, and this could hurt their tourism revenue. Critically, Italy’s banks are in very bad shape, and coupled with a flat economy and high debt-to-GDP ratios, Italy could very well be one of the triggers of the next great crisis, and may well be the cause of the EU collapsing. But this talk has been going on for the last 3 years, so until something finally gives way, we’re just going to have to bide our time.
Germany’s economic slump is largely down to the US-China trade war. Looking into the numbers with greater detail, Germany’s economy isn’t in a recession yet, but teetering on the edge of it because of the poor sentiment being felt in the German economy as a result of the trade war fallout. What that means is, Germany’s economy is, like China and Singapore, being artificially strangled by the trade war issues. Until the trade war eases up, or disappears, Germany will likely stay depressed, maybe enter a technical recession, but overall should not spiral into a steep fall.
Hong Kong and China: Of Protests and Trade Wars…..
Hong Kong is currently experiencing violent protests and rallies, so expect Hong Kong’s markets to be slow and flat for the near-term until their political issues get resolved.
China is basically facing the same issue as Germany as the US-China trade war takes a hit on the Chinese economy. Recent economic numbers showed a significant drop, and it seems that the pressure is mounting for them to find ways to keep their economy in good shape. All this could force China’s hand in striking a win-win deal with Trump, which is of course what Trump will want, but only once the FED cuts rates to a level that Trump is happy with. So until then, we’ll wait.
Yield Curve Inversions? Not when the game has changed…..
A yield curve inversion has for the longest time, been thought of as an indicator that a recession is looming, with all 9 previous inversions preceding a recession that came anywhere between 6 to 24 months later. However, over the last decade since the subprime crisis, central banks have undertaken mass bond purchases. Most notably the ECB and the Fed. Such methods have likely dampened, if not completely discredited yield-curve inversions as a reliable predictor.
All the economic data we are seeing looks more like an economic slowdown instead of a full-blown recession. With this latest market selloff more than likely a result of artificial chokes on the global economy (see Trump and US-China Trade War).
The current selloff is based on the FEAR that a recession is looming ahead, but the recession is not here yet, and until the data starts to show it, we do not need to worry too much, other than managing the risk in our portfolios, taking profit when necessary, and finding opportunity in a market dip.
Above all, investors and traders need to be aware of this: markets evolve.
And I do believe the game has changed….