2 Year/10 Year Treasury Curve Flattens To Just 26 Basis Points

Stocks Rebound On Thursday

It seems like economic fundamentals and earnings are in a heavyweight battle with the trade skirmishes to determine the direction of the stock market. It rallies when the skirmishes aren’t in the news and declines when new announcements are made. That’s the best explanation I can give for why stocks sold off sharply on Wednesday and then rebounded almost exactly the amount they fell on Thursday. The S&P 500 was up 0.87%.

I’ve been discussing the relationship between the Dow and the Russell 2000 to show if trade skirmish fears are occurring. The Dow was up 0.91% and the Russell 2000 was up 0.39%. This tells us the trade war worries weren’t in play on Thursday. The industrial sector was up 1.12%, which also means trade war worries weren’t in play. Tech did the best as it rallied 1.79%. The FAANG stocks did well as Amazon and Facebook hit records a couple weeks ahead of their earnings reports. The tech sector and the Nasdaq hit record highs.

The financials underperformed as they were up 0.19%. If the big banks report great earnings results, then the S&P 500 will hit a new record high in the next few days. That’s a big “if” because they mostly beat EPS estimates last quarter, but I wouldn’t count the reports as great because the equities didn’t respond positively. Sometimes stocks don’t rally a few days after they beat estimates because they were overbought heading into the report, but poor performance after 3 months tells us the reports weren’t great.

Treasury Curve Flattens

To be clear, not everyone believes the trade skirmishes are the reason stocks have been stuck in a range for the past 6 months. Some believe that the yield curve is worrying investors about a peak in the cycle. Like I mentioned, the yield curve is widely watched. If you think a crash will occur a year after the inversion and you think an inversion is going to occur in 3 months, then selling now could make sense. You will leave some profits on the table, but you will avoid the losses incurred in the next bear market. The calculation entails figuring out how deep the losses will be in the next bear market. Obviously, if you think another +50% crash is coming then you should sell now. However, if the next bear market reaches a 30% decline, selling now and missing a big chunk of the end of the bull market might not make sense. To be clear, I stated the crash occurs 1 year after the inversion because many believe the stock market is forward-looking. I think the stock market is a coincident indicator, but then again I also wouldn’t be bearish because of the yield curve flattening since it does well historically at this point in the cycle.

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