After a few months of coming close, the yield curve has finally met the flattest point since before the last recession. The difference between the 10 year and the 2-year bond yield is 76 basis points which is tied with the summer of 2016 for the lowest difference this cycle. Meeting the low could be a technical signal that sends the yield curve closer to an inversion. As of now, it doesn’t mean much. The chart below comparing the Dow to the yield curve shouldn’t cause investors any concern because recessions usually occur after the yield curve is inverted.

Monday was another great day for stocks as all major indexes rallied. The Dow was the best performing one as it was up 0.37%. Oddly, the VIX was up 3.12%. It still is below 10 meaning volatility is very low. If October ended today, the VIX would have the lowest average for a month ever. The chart below is another way to look at the lack of movement in stocks. It shows the number of days in the year where the S&P 500 has moved up or down 1%. This year there have been less than 10 days with a 1% move. We’ll see if central banks’ asset purchases have anything to do with the volatility suppression next year when QE is shrunk.

Before I get into the updated situation in Europe, let’s look at the Barclays’ survey about which parts of Fed meetings are the most important and which are the least important. The individual voting records aren’t considered essential because some of the voters are rotated. Most of the votes aren’t surprising because we know who is the most likely to be hawkish and who is the most likely to be dovish. Interest rate projections not being considered essential shows how the Fed has lost credibility. Long term projections are guesses based on the current information. They change often, meaning they don’t have much accuracy. The transcript of the policy meeting gives us a good overview of what the Fed changed its mind on. The press conference allows for questions to be asked which gives us clarification on ambiguous points. The Minutes are great because they tell us everything the Fed considered before making its decisions.

Bloomberg is reporting the ECB will probably cut the QE in half to 30 billion euros per month for 9 months and then end it a few months later. It’s a tough decision for the ECB because growth is accelerating, but inflation is stagnant. The Phillips Curve shows the relationship between inflation and unemployment. Inflation is supposed to go up when unemployment falls. However, in both Europe and America, inflation hasn’t rebounded. The chart below shows QE having no effect on core and super core inflation. I wouldn’t be surprised if inflation remained the same after QE is cut in half. I will be focused on the currency market, the bond market, and the stock market after this announcement is made next Thursday. The more QE, the more the risk on trade gains support; the less QE, the bigger the chance there’s a sell-off in risky assets.

In the last article, I showed the 20 year average PE compared to the current PE of stocks. Technology is cheap according to that metric. The bearish thesis bets on the current profitability rate of tech stocks not being sustainable. The chart below reviews the 20 year profit margin range of each sector. The S&P 500 is at its margin peak. It’s not a given that margins will fall because some of the sectors like industrials, energy, and telecommunications have room to run. Tech stocks are operating well above their 20 year high. Tech has undergone the most changes in the past 20 years, making this stat the least relevant for this sector. Google didn’t even exist 20 years ago. It’s tough to come up with normalized margins for firms which haven’t been around for more than 2 business cycles. During the 2008 recession, Blackberry dominated the smartphone market. The world is a completely different place now. The different expectations for how tech earnings will respond to a recession is what makes the market.

Speaking of the tech stocks, one of the leaders of the group, Netflix - NFLX reported earnings on Monday night. The “N” in FANG reported $2.98 billion in revenues which beat estimates for $2.97 billion. Adjusted earnings per share were 37 cents which beat estimates for 32 cents. Net subscriber adds were 5.3 million which beat estimates for 4.5 million net adds. This a 49% increase year over year. There were 850,000 net adds in America and 4.45 million net adds internationally. Guidance was for 6.3 million net adds in Q4. Guidance for content spending in 2018 was increased from $7 billion to $7-$8 billion.

This brings us to the critical point on NFLX stock which determines its direction. Most bears cite the chart below which shows how Netflix has negative free cash flow. In the past few years, NFLX has been trading on whether it adds more or less subscribers than estimates. The bulls say the only things that can bring down NFLX’s stock are the inability to get financing and the customers not liking the content. That has proven to be correct in the past few years, but the bears still think that at some point the cost of content is going to catch up to the company and crater its stock which has an earnings multiple in the triple digits.

Conclusion

The bears got some fodder today as the yield curve flattened to 76 basis points and NFLX reported another quarter with negative free cash flow. Unfortunately for them, it’s more of the same for the market as the indexes rallied to record highs. There have been less than 10 days this year where the S&P 500 moved 1% or more, reinforcing the notion that this is one of the calmest years in stock market history.