In the past four days, stocks have peaked in the morning and then fallen in the afternoon, sometimes into the negatives. I think there is a technical battle between those who want the market to retest the recent trough and those who want the market to make new highs. On Thursday, the S&P 500 was up about 1% in the morning, but closed up only 0.10%. The Dow was up 0.66% as it was led higher by United Technologies, which was up 3.3%, and Caterpillar, which was up 2.3%.

10 Year Bond Yield Should Fall

The 10 year bond yield was down 3.3 basis points to 2.917% just after I said it was bound to fall in the next month. I won’t claim victory after one day of action because the call is for a decline of about 20 basis points from the peak of 2.95%. I don’t think there will be major problem if the 10 year hits 3%, but so many people are afraid of this occurring that it could be a self-fulfilling prophecy. That’s a technically driven call because there’s no fundamental reason why anything crazy should happen based on a few basis points of movement.

As you can see from the chart below, the CFTC net speculative position in bonds is at an all-time low. This should cause a panic buying in the 10 year bond just like there was panic buying in the VIX when the short VIX trade unwound. The same thing happened in oil as the price fell sharply a couple weeks ago. There are fundamental reasons for all the trades (long oil, short VIX, short treasuries) to continue, but corrections occur to keep everyone from getting too aggressive.

10 Year Yield Versus S&P 500 Firms’ Yields

The chart below provides another bit of context into the TINA trade. Personally, I don’t think the TINA trade is the main reason for the bull market because bond investors and stock investors have different risk preferences. I would argue that only the utilities, telecom, and consumer staples sectors are affected by changes in yields. Some stocks with high dividends trade like bonds, but most don’t. As you can see from the chart below, the percentage of companies with a yield higher than the 10 year treasury is about 20%. This is down from the peak of about 60%. The chart supports my theory that low yields don’t push many investors into stocks because it shows there were barely any stocks with a yield above the 10 year in the 1990's, yet the stock market was the most expensive ever in that period.

Oil Spikes On Thursday To A 2 Week High

On Thursday, the WTI futures were up 1.6% to $62.66. The futures reached a 2 week intra-day high above $63. This rally comes on the heals of the selloff I mentioned the CFTC futures contracts predicted earlier this month. American crude inventories fell 1.6 million barrels last week. This number was much lower than the expected increase of 1.8 million barrels. Net imports fell to 4.98 million barrels per day which is the highest since the EIA started measuring this in 2001. Exports increased to 2 million barrels per day which is slightly less than the record 2.1 million barrels per day exported in October. Crude stocks at the Cushing, Oklahoma hub fell 2.7 million barrels. Inventories are down because the oil market is in backwardation which is when the spot price is above forward contracts. Eventually, when the selling intensifies enough, the market will go back into contango which is when forward prices are higher than the spot price.

As you can see from the chart below, the 1.6 million barrels per day decrease in inventories pushed them down to 420.5 million barrels per day. This was the first decrease in the past 4 weeks. Inventories are now down 18.9% year over year. That’s the largest year over year decrease in at least 22 years. The chart labels the seasonal movement. Ignoring the seasonal movement, the overall trend in inventories is still down. Keep in mind, they are falling from record levels back towards the long term average.

Housing Cycle Is Mature

I think the housing cycle is in its maturation phase. The chart below shows the percentage of first time home buyers reached the highest point in 17 years. Furthermore, the median down payment first time home buyers given the bank has been 6% in the past three years. The bottom before the housing crisis was 2%. To be clear, I think the housing market has a couple more years of improvement just like the overall economy. The demographics support a larger percentage of home purchases being from first time buyers because millennials are just entering the fray. The most common age in America is 26. Over half of 26 year old millennials will need to buy a house.

To be clear, when the housing market has a decline in the next recession which should occur in about 2-3 years, the market won’t crash like the prior cycle because the loans given out to borrowers were of higher quality. There haven’t been variable rate, no down payment, no documentation loans given out this cycle. Even though median down payment is low, debt to income ratios are reasonable and the average credit score of borrowers is much higher than the last cycle.

Conclusion

Either the stock market is in an epic battle between the bulls and the bears or it’s in a holding pattern. The stock market was up way too much too quickly in January, so it makes little sense to visit that price again just a few weeks later. We’ll probably see a gradual grind higher in the next few months. Remember, my prediction to start the year was a 10%-15% decline where the market then rallies in the next 12 months without reaching a new high; then I expect it to fall in 2019 as the market begins to price in a recession in 2020. There’s a possibility that this time frame is off by a bit, but I’m sticking with it as a framework to view the market.