Every day, the financial markets send lots and lots of signals which investors, traders and economists can use to try to decipher what other investors are thinking and may be seeing which they themselves are not yet seeing. Today, August 14, some of the signals were particularly strong: the Dow Jones Industrial Average was down 800 points, many other US equity indices were also down about 3%, copper (used in many industrial products and therefore a good indicator of future industrial activity) was down 1 1/2%, oil was down 3.7% and most of the $1bn+ market cap digital currencies were down 6-10%. Meanwhile, the bond market also provided lots of news today: the yield on the 30 year Treasury bond briefly traded today lower than ever (2.018%) and the yield on the 10 year Treasury bond briefly traded lower than the yield on the 2 year Treasury note — which is called an “inverted yield curve”. Common sense dictates that investors would typically want a higher yield for lending their money even to Uncle Sam for 10 years than for lending him money for 2 years. However, sometimes, investors are so worried about the future that they want to lock in that certain repayment for 10 years rather than risk their money elsewhere. Uncle Sam is one of the few governments that can still issue more currency (which causes higher inflation) if ever there is a risk it can’t pay back its loans. That’s how Uncle Sam paid back its massive WWII debts — by printing money — especially in the 1970s (which is one of the key reasons inflation in the 1970s was so particularly bad). Back to inverted yield curves — Every recession since WWII has been preceded by an “inverted yield curve” of lower 10 year Treasury yields than 2 year Treasury bond yields. Of course, it’s not true that every inverted yield curve has presaged a recession; but, it is true that every recession has been preceded by one.
So, what does all this mean?
Of course, we don’t really know; but like a forest ranger posted in a look-out station, our job is to look for smoke so we can find the fire. With that, we can try to decipher what investors and traders were thinking about today.
Our first observation is that “the Dow” (Dow Jones Industrial Average, or DJIA) was down 400 points this morning from the close of trading yesterday. So, there was already news this morning that caused more equity traders to sell than to buy.
Then, as the day continued, the Dow fell another 400 points.
It may be true that news of the yield inversion scared some equity traders today but I think that is unlikely. I don’t think equity traders suddenly wake up to what the bond market is telling them and suddenly believe it.
I think it is more likely that the continued stock market declines today were more of a function of the new news that Huawei, the big Chinese telecom manufacturer at the crux of much of the trade tension between China and the US, helped spy on opposition candidates for some African governments. Given US concerns about Huawei’s ability to install spy equipment or software into its devices and the importance of the company in the Sino-US trade negotiations, I think this caused many traders today to fear that the US-China trade negotiations are more likely to take more time than less time.
This reverses the good news the markets learned yesterday about the delay in the US action to impose tariffs on some Chinese goods.
However, yesterday, we saw digital currencies (BTC, etcetera) trade to lower prices — in keeping with the “risk off” trade out of gold and bonds.
So, if digital currencies were trading with bonds and gold yesterday, why did digital currency prices trade lower today, when gold and bond prices were higher today?
Again, we can’t say for certain. We can only observe what actually happened. What we observed today has already been noted.
And it is really different than what happened yesterday.
Today, digital currency prices went down with risk assets (oil, copper, stocks). I think yesterday traders were making the decision to move into stocks, which are ownership stakes in companies, whose likelihood for higher profits went up yesterday when Trump decided to delay US action on tariffs on more Chinese goods. However, I think today traders were assessing today’s bad news as worse than how good yesterday’s news was.
In other words, yesterday we learned that tariffs were likely to be delayed for a few months.
But today we learned that one of the key issues causing the tariffs to exist (US fears of Chinese corporate and governmental espionage) may be even more severe than previously believed, which may cause the trade war to worsen, which would be bad for profits globally, which would mean less wealth globally, including for people wanting to protect some of that wealth via digital currencies.
As corroboration for this theory, the markets gained more data today that the Chinese and German economies are slowing — indicating not only the prospect of lower profits going forward but also a higher probability of lower profits going forward.
Thirdly, other market participants in the US today increased their assessment that the Federal Reserve of the US (the US central bank) may lower overnight US interest rates by 1/2 percentage point when it meets in September. Because bond prices trade inversely to yields, bond prices would go up on this new assessment of possibly even lower rates than previously expected. These higher bond prices necessarily would cause yields of 10 year Treasuries and 30 year Treasuries to reduce. If stock market participants were taking their cues from bond traders and bond traders were simply reassessing probabilities of Fed action in September, the market may have been caught up today in a vicious circle (the opposite of a virtuous cycle).
We will discuss these phenomena more over the next few days but traders and investors are reminded to watch as many market indicators as possible, be on the look out for a Minsky Moment and Black Swans while also always weighing the probabilities between further vicious circles or a return to a virtuous cycle.
Tim Shaler is Chief Economist of iTrust Capital. He is a published Real Estate economist, was a portfolio manager and asset allocation expert at his previous firms and is an adjunct professor at Webster University. His MBA (Finance) and MA in Russian Economic History are both from the University of Chicago.
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