Falling Treasury Yields Take Center Stage As Investors Appear To Be Playing Defense

The “three horsemen” of risk are storming down the track this week, most obviously in the Treasury market. When investors get cautious, they often start piling into Treasuries, volatility, and gold, and the rally in Treasuries has been relentless lately. Volatility is also racing higher.

By early Wednesday, 10-year Treasury yields—which fall as prices rise—slipped below 2.23% for the first time since late September 2017, and U.S. stocks remained under pressure. Stocks in Europe are getting crushed Wednesday after a mixed performance in Asia. Yields overseas are below zero in some cases. Back home, the closely-watched gap between 10-year and three-month yields is the lowest since March. 

There was aggressive buying in Treasuries all day Tuesday, as we’ve basically transitioned from a “risk-on” market a month ago to a “risk-off” market now amid worries about European elections, Brexit, and last but not least, China. It’s a weird time geopolitically, and people are trying to figure it out. At times like these they often go to places that might look safer, though no investment is truly “safe.”

A couple weeks back, we discussed how the biggest risk for the market was people adopting a cautious mode as the tariff situation plays out. This appears to be happening right in front of our eyes, as yields have gotten quite low by recent standards. Meanwhile, the S&P 500 Index (SPX) finished Tuesday just above psychological support at 2800. A drop and close below that today could potentially trigger follow-up technical selling.

Remember last summer when one of the big market fears was rising rates as 10-year yields kept rolling up gains to peak above 3.25%, helping crush a stock market rally? Seems like a long time ago, because now it’s the opposite situation. There’s growing fear that the relentless dive in yields might signal looming economic issues, and some of the latest manufacturing and corporate spending data do look a bit soft. However, it’s possible that the economy might end up in relatively decent shape if the trade situation gets resolved.

Crude extended its losses early Wednesday, with the U.S. front-month contract falling to $57.26 a barrel. Falling crude prices also can signal lagging faith in the economy, since crude tends to rise when economic demand grows. This is the lowest level for front-month crude since March 12.

Watching Tariff Impact on Confidence

You could be forgiven for getting bored reading about the trade dispute with China, but there’s no way to avoid it for anyone keeping track of markets. On Tuesday, JPMorgan Chase & Co JPM CEO Jamie Dimon said that the trade battle could damage corporate confidence, CNBC reported. He warned at a conference that it’s more than just a “skirmish.” Dimon tends to be one of those CEOs whom investors listen pretty closely to, so his words carry weight.

In addition, a Bloomberg Economics study found that the tariffs so far could reduce China’s quarterly gross domestic product (GDP) by 0.5%, while the U.S. and the rest of the world would see a 0.2% drop in 2021, media reports said. One thing to consider keeping in mind, however, is that the U.S. economy isn’t necessarily as exposed to trade currents as some other countries, with trade a lower percentage of its GDP than, say, China.

There was tough talk out of China overnight about a possible export ban on rare earth minerals, which go into products like electric cars and wind turbines. China makes most of the world’s rare earth supplies, and shares of some rare earth miners have been climbing. China is “seriously considering” restricting rare earth exports to the U.S., the editor of Chinese state-run Global Times tweeted this week, according to the BBC.

On the plus side, U.S. consumer confidence remained strong, rising to 134.1 in May and beating Wall Street’s consensus estimate of 130, The Conference Board reported Tuesday. So far, it doesn’t look like consumers are worried too much about the trade situation, at least by that metric. More data are due later this week, including the government’s second estimate of Q1 gross domestic product (GDP) on Thursday and Personal Consumption Expenditure (PCE) prices Friday—an important inflation indicator. Today, however, looks a bit light on data.

One thing that potentially could hurt confidence is if some of the big Info Tech companies start to suffer from the China standoff. Some analysts are wondering if we’ll see these firms start lowering guidance at some point. It hasn’t happened yet, but the Q2 earnings season looms only a little over a month away, so that’s another thing to potentially be concerned about. Semiconductor stocks started the week on a soft note, and are having their worst month since 2008.

Earnings look a bit light today, but a couple crop up tomorrow that could be worth watching, namely Costco Wholesale COST and Gap Inc GPS.

Jumping VIX

Another thing to consider is volatility, which put on a big move higher to start the new week. The Cboe volatility index (VIX) moved above 18 early Wednesday, but one sign that maybe things aren’t quite as bad as some people think was its failure to climb back above 20. That level marks recent highs, and a test of it could cause more people to get nervous. For now, though, it doesn’t look like there’s reason to panic.

VIX actually gave the rest of the market a tip-off Tuesday, something that could serve as a lesson in the future. A rising VIX and a rising SPX early in the day had some people scratching their heads, but it turned out stocks started to feel pressure by midday, perhaps in part due to rising volatility. As VIX went higher, it looked like it was trying to tell the market something. So the lesson is, if VIX is rising but stocks aren’t reacting, consider waiting to see what happens. 

From a technical perspective, last week wasn’t a complete washout for the SPX, as it managed to fend off a move below the key psychological level of 2800. After Tuesday’s descent, 2800 remains a possible pivot point, with the 200-day moving average of 2776 below that as a second potential support area. You have to really crane your neck now to see the 50-day moving average up at 2871. Last week it looked like that might get tested, but not so much now.

One could argue that after so many losing weeks in a row, the market needs a few strong days. It looked like it might get one early Tuesday, but rising volatility and investors fleeing into Treasuries appeared to quash those hopes pretty quickly. Today is a new day, though.

Figure 1: SOX SLIPS LOWER: The Philadelphia Semiconductor Index (SOX) had another rough day Tuesday and is suffering its worst month in 11 years. Worries about the China market weigh, and so do concerns that a general dark mood in the Info Tech sector could remain a headwind. Data Source: Philadelphia Stock Exchange, Nasdaq. Chart source: the thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Mouse Roars: Here’s some early summer news that sounds good not just for Walt Disney Co DIS, but for the economy in general: Theme park attendance is at all-time highs. Attendance at the world’s 10 biggest operators of amusement parks increased 4% last year and reached the half-billion visitor mark for the first time, the Associated Press reported. This includes all kinds of amusement parks, including those water parks you take your kids to. It also includes the famous theme parks run by DIS, which benefited from new film-based attractions, the AP reported. If you’re wondering who the next-biggest amusement park operator is after DIS, it’s Merlin Entertainment Group, which owns Legoland. Still, Magic Kingdom in Florida remains the most visited theme park in the world. 

It could be interesting to see if people keep packing their families into crossovers and heading to amusement parks at growing levels this year, considering the economic slowdown in parts of the world. Another question is whether DIS might suffer any attendance losses at its mainland China park due to the tension between the Washington and Beijing. In its earnings call early this month, however, the company said “business actually has been quite good lately” in China. 

Risk Market?: Speaking of China, stocks there have been doing worse than U.S. stocks since a month ago, when the trade dispute worsened. As of Tuesday’s close, Shanghai stocks were down 11% from their closing high of 2019 posted in mid-April, compared with about a 5% drop from highs for the S&P 500 Index (SPX). However, Chinese stocks are up 16% year-to-date, which is better than the SPX’s 12% year-to-date gains. Many investors appear to have embraced stocks in China and other emerging markets this year after recent weakness, but the ongoing trade dispute could represent a caution flag, especially with Chinese Internet stocks that might be hurt by U.S. tariffs and intellectual property disputes related to the trade battle. 

If you’re buying those names, you’re buying more risk than normal, perhaps similar to the risk you might take on if you were buying shares of a company in litigation. So that’s an extra element to consider keeping in mind. That’s not to discourage people from having some assets in foreign market stocks, but only a reminder that we’re not out of the woods yet on China and there might be more downside to come.

Pay as You Go: One area of the market that’s rising lately is the payments sector, meaning credit card stocks and companies like PayPal Holdings Inc PYPL. The traditional credit card stocks like Visa Inc V, American Express Company AXP, and Mastercard Inc MA have done very well, but if we have an economic slowdown, it might make some people nervous about these names. Barron’s had an article over the weekend talking about the payment firms, and that might have helped those companies Tuesday. Barron’s even coined a cute little name for Mastercard, Visa and PayPal, calling them “MVP” stocks and noting they’re outpacing the FAANGs.

It’s kind of an interesting part of the market, because it’s a combination of Info Tech and Finance. It looks like MA, AXP, and V got some new life through their partnerships with Apple Inc AAPL. Square Inc SQ, another competitor in this space, hasn’t gotten it going as much on the stock market front, but it’s making a splash in the real world, as anyone who’s taken a cab ride recently may have noticed. And it looks like many younger people are increasingly using Venmo—a PYPL peer-to-peer payments product—to pay each other.

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