Yield Curve Remains Inverted, Government Says GDP Expanded Less Than Thought

As U.S.-China trade talks drag on, the drumbeat of lackluster economic news also continues as fresh data showed the U.S. economy expanded less than originally thought in the last quarter of 2018 and the inverted yield curve appears to be keeping investors on edge. 

Trade negotiations between the United States and China seemed to come back into focus Thursday morning, as Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin are in Beijing for a fresh round of talks between the world’s two largest economies. Reuters reported that China has made unprecedented proposals on issues including forced technology transfer but that there wasn’t a definite timetable for a deal. 

On the economic data front, the U.S. government said the economy expanded less than previously thought in the final quarter of last year, with its third estimate of Q4 GDP showing an annualized rate of increase of 2.2% compared with a previous reading of 2.6%. A Briefing.com consensus had expected a reading of 2.5%.

Of course, it might also be on investors’ minds what GDP ends up being in this quarter, which closes out at the end of the week. We won’t find out until late next month, but the Atlanta Fed’s GDPNow indicator for Q1, updated yesterday, rose to 1.5% from the previous 1.3% after news Wednesday that the U.S. trade deficit narrowed in January, increasing its estimate of the contribution of net exports to Q1 real GDP growth. 

The mood on Wall Street overall seemed pessimistic as U.S. stock trading on Wednesday appeared to be dominated by worries about where the U.S. economy is headed, as indicated by the U.S. Treasury market.

The yield on the benchmark 10-year Treasury was below 2.4% as well as being below the yield on the 3-month Treasury on Wednesday, continuing a pattern – called an inversion – that has preceded recessions in the past. 

Although it was mostly red across the board, the market’s losses weren’t particularly large, perhaps indicating that there is room to quibble about how solid the link is between an inverted yield curve and a contraction in the economy. 

While lower rates in the future are typically associated with a slowing economy, according to public comments from former Fed Chair Janet Yellen, they may be a sign that the economy could use an interest rate cut rather than indicating a looming recession. 

With the prospect of relatively low interest rates lasting well into the future and potentially weighing on bank profitability, you might think that bank shares would be among the worst performers of the day. But on Wednesday, losses in the Financials sector were about in the middle of the pack. 

Airlines Flying High

Although it didn’t rise by much, the S&P 500 Industrials sector was the day’s lone gainer Wednesday. Airlines including American Airlines (AAL), Southwest Airlines Co LUV, Alaska Air Group, Inc. ALK, Delta Air Lines, Inc. DAL and United Continental Holdings UAL were among the best performing stocks in the group, along with plane manufacturer Boeing Co BA.

It appears that investors were encouraged by indications from LUV, the largest operator of the BA 737 Max, that the impact from grounding the planes after two fatal crashes wouldn’t be as bad as some investors had thought, according to a Bloomberg report. Meanwhile, BA said it had improved its automated flight control system software.

Although many of the Dow Jones Industrial Average ($DJI) components were lower Wednesday, all of Dow Jones Transportation Average ($DJT) stocks were higher. The transportation average is often considered a bellwether for economic health because if airlines, rail companies, trucking firms and parcel services are humming along then commerce probably is too. So with strength in the $DJT, the economy may not be as bad off as some market watchers might be thinking. 

In other good news for transportation companies, U.S. oil prices dropped on news that crude inventories in the nation rose by 2.8 million barrels when a decrease had been expected.  

Fuel prices are a key input cost for airlines, rail companies and couriers such as FedEx Corporation FDX, and a dip in prices would be a welcome relief for them as well as for everyday drivers spending money at the pump. But despite Wednesday’s drop, the U.S. oil price, around $60 a barrel, remains the highest it’s been since early November amid OPEC cuts and U.S. sanctions on Venezuela and Iran. 

Lower oil prices are a double-edged sword, as they can indicate a sluggish economy or expectations that global economic growth could falter. But even with such an outlook, crude may have some support as we’re heading into what’s seasonally a strong time for crude demand.

Elastic Demand

After the market closed Wednesday, Lululemon Athletica Inc LULU reported results that beat expectations on both top and bottom lines and said its same-store sales rose 16% in the quarter that included the holiday season. The retailer’s shares were up around 14% in premarket trading this morning.

From a consumer health standpoint, the better-than-expected results offer a counterpoint to data earlier in the week that showed consumer confidence for March unexpectedly fell. According to the Conference Board, its index of consumer confidence dropped to 124.1 from 131.4 in February. A Briefing.com consensus had expected a reading of 132. 

Of course, LULU’s reporting period and the Conference Board numbers are for different time frames, and we’ll have to wait and see how the company and other retailers fare during the current quarter and to what extent the worries on Wall Street might trickle down to Main Street. 

But it is encouraging that the LULU reporting period encompassed the end of last year, when the stock market was tanking. With shares on a much better footing now, it could be interesting to see how the consumer confidence figures translate into actual spending at the cash register or keyboard.

Yield Faltering: The yield on the 10-year Treasury continued to fall Wednesday amid economic growth worries. The benchmark was also below the yield on the 3-month Treasury, a so-called “inversion” that has worried many about the possibility of a recession.Data Source: Cboe Global Markets. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Rate Cut on the Horizon?: Stephen Moore, an economist who may get nominated by President Trump to the Federal Reserve Board of Governors, made some waves Wednesday because of comments in an interview with The New York Times that the central bank should cut rates by half a percentage point. What Moore said doesn’t seem too far removed from what some investors appear to be thinking. The CME’s FedWatch tool on Wednesday was projecting a nearly 35% chance that the Fed could cut rates by 50 basis points (or half a percentage point) before the end of the year. There was an almost 75% chance of at least one rate cut, or 25 basis points. That’s quite a contrast from just a month ago, when futures only indicated about a 15% chance of any rate cut at all this year, and probably reflects global growth worries that accelerated recently, along with the Fed’s dovish meeting outcome. The Fed’s next meeting is in May, and chances of a rate cut then are only seen at 8%, according to CME futures prices on Wednesday. So if anything does happen, it’s likely to be further out in the year.

Buying and Holding: Many financial advisors recommend a buy-and-hold approach for everyday investors rather than trying to time the market. With all the worry about whether the inverted yield curve signals a recession or not, it might be a good time to remind yourself of that. “Even though a recession is just a matter of time, attempting to time one will likely frustrate more investors than reward them,” according to investment research firm CFRA. And of course there’s the adage from legendary investor Peter Lynch: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” 

Window Dressing: While much attention has been paid to the inverted yield curve on top of worries about slowing global growth and corporate earnings, there may also another factor behind the pressure on the market of late. “It is normal for digestive declines to follow share-price surges, like the 21% advance seen by the S&P 500 since December 24,” CFRA said in a note Wednesday.  “Yet we see no recession on the horizon and think that end-of-quarter window dressing should be added to the lengthening list of factors deserving of blame.” Still, the firm notes that yield curves have typically inverted around a year before recessions since 1960, and three of four economic recessions were preceded by earnings recessions.

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