Wall Street rises on trade optimism; Boeing slides (Reuters)

Screen Shot 2019-10-21 at 9.38.01 AM(Reuters) – Wall Street kicked off the week on an upbeat note on Monday after the United States and China showed some signs of progress in resolving their trade war, but a fall in Boeing’s shares pressured the blue-chip Dow index.

White House adviser Larry Kudlow said that tariffs scheduled for December could be withdrawn if trade negotiations go well, adding to optimism from remarks by President Donald Trump that a trade deal could be signed by mid-November.

U.S. chipmakers with a large exposure to China rose, with the Philadelphia Semiconductor index .SOX up 0.9%. Trade-sensitive technology stocks .SPLRCT also gained 0.3%.


Is the Banking System’s Recent Liquidity Crunch a Potential ‘Iceberg’?

MarketCommentary2016-croppedDear Readers:

For the most part, September was another month of nervous stability for the financial markets—until the very end. As September gave way to October, the stock market took another big dip, with the Dow Jones Industrial Average falling around 900 points in two days. This latest swoon was attributed mainly to news that the US manufacturing index posted its weakest reading since 2009.* While President Trump blamed the Federal Reserve, many economists blamed the Trump-China trade war—all while most of the headlines continued to focus on Congress’s new impeachment inquiry into the president. 

So far, Wall Street seems to be shrugging off the impeachment issue, and the stock market remains basically locked in the same nervous holding pattern it’s been in since the start of 2018. However, that could change—particularly when you factor in all the other uncertainties affecting the markets these days, which include recession fears, new Middle East tensions, and a partially flat yield curve. 

Liquidity Mystery 

Another new uncertainty also emerged in September that didn’t get a lot of attention—though we think it may be just as significant than any of the other potential warning signs we just mentioned. On September 16th, the US banking system experienced an overnight liquidity crunch in which, suddenly, banks didn’t have enough cash on hand for repurchase agreements, a.k.a. repos. As a result, the Fed Funds Rate momentarily spiked to 10%. This occurred just days before the Fed was set to lower the rate from 2.25 to 2%. With no other choice, the Fed had to step in and immediately pump cash into the banking system, pledging to allow roughly two weeks of overnight repo transactions, each injecting around $75 billion daily into the economy.**

What’s so unsettling about this development is that no one really has a definitive explanation for how it happened. Fed Chairman Jerome Powell tried to attribute it largely to massive cash withdrawals from bank accounts to pay their September 15th tax estimates.*** To us, that theory doesn’t hold water for several reasons. One is that such withdrawals occur annually every September 15th without creating a liquidity crunch. Another is that Trump’s corporate tax cuts should have made a crunch even less likely, not more. 

Others have blamed the incident on new rules stemming from the financial crisis, which say banks must keep more reserves in US treasuries, leaving them less available cash to meet customer demands. However, those rules have been in place for over 10 years now without a sudden crunch like this occurring—so that theory doesn’t cut it for us, either. 

The main point here, we believe, is that somebody probably does know exactly what caused the incident, but no one is talking about it. As advisors, we get nervous in this kind of situation because it feels eerily familiar. 

Iceberg Ahead? 

Remember that in 2008, it wasn’t until it was too late that we learned how the banks had all tied themselves together with credit default swaps. They had all reinsured one another so that once one bank failed, they all came down together. Until that point, many analysts were predicting the subprime mortgage crisis might cause a bump in the road for the economy, but nothing more. It was like an iceberg: some danger was visible above the surface, but the extreme extent of it remained hidden until we crashed into it! 

Is it possible this liquidity emergency in September is evidence that banks have tied themselves together again in some other way—with interest rate swaps, for example? It seems unlikely to us that a majority of banks would have suddenly all run out of cash at the same time. It seems more likely that the crunch would have started with just a few banks but impacted the entire system due to an underlying connection that we may not yet know about. 

The bottom line is that, even though this incident didn’t grab a lot of headlines, it should give investors pause. Could it be early evidence that another financial crisis of some kind is brewing? No one knows, of course. However, with the third major correction of our current long-term secular bear market cycle long overdue, and with so many other red flags out there now, it’s important to at least be aware of it—particularly if you’re still not sure you’ve adequately reduced your own stock market risk. 

As always, we encourage you to share this information—and this newsletter—with friends or family members you feel may be in danger of getting caught in the next sustained market downdraft. While it’s possible (although unlikely) that this incident could merely be a financial fluke, it could also be the proverbial tip of the iceberg. 

*“US Factory Gauge Hits 10-Year Low as World Slowdown Widens,” Yahoo Finance, Oct. 1, 2019

*“Why the Repo Market is Such a Big Deal—and Why its $400 Billion Bailout is So Unnerving,” fortune.com, Sept. 23, 2019

***“Fed Actions and Statements This Week Indicate Major Risk of Near-Term Economic Downturn,” Numismatic News, September 29, 2019

Great news! TD Ameritrade has made the move to $0 commissions

Screen Shot 2019-10-07 at 10.47.15 AM.png
Dear Readers:
You may have seen the news – our custodian TD Ameritrade is eliminating base commissions for online exchange-listed stock, ETF (domestic and Canadian), and options trades, moving from $6.95 per trade to $0.00 per trade.
TD Ameritrade Institutional has been a valued strategic partner to our firm and we’re thrilled by their move to lower the cost of investing and trading for you. The change goes into effect on October 3, 2019. That’s when you should start to see lower commissions on qualifying trades in your account(s).
Please see the company press release for additional details on this milestone announcement: The Best Just Got Better: TD Ameritrade Introduces $0 Commissions for Online Stock, ETF and Options Trades
As always, we’re here for you if you have any questions about these exciting changes.
All of us at @financial

Wall Street opens higher on Apple boost (Reuters)

Screen Shot 2019-09-30 at 9.19.08 AM.png(Reuters) – Wall Street’s main indexes opened higher on Monday, lifted by Apple Inc, as investors shrugged off last week’s reports that Washington was considering delisting Chinese companies from U.S. stock exchanges.

The Dow Jones Industrial Average .DJI rose 32.08 points, or 0.12%, at the open to 26,852.33. The S&P 500 .SPX opened higher by 5.28 points, or 0.18%, at 2,967.07. The Nasdaq Composite .IXIC gained 24.46 points, or 0.31%, to 7,964.09 at the opening bell.

Click here to read the full article:

The Fed cut rates for the second time this year (CNN Business)

Washington (CNN Business) The Federal Reserve on Wednesday cut interest rates by a quarter percentage point for the second time since July, as concerns grow about a potential global slowdown.

Officials also left the door open for another rate cut this year if the economy weakens further, reinforcing the message by Fed Chairman Jerome Powell that policymakers will do whatever is necessary to prevent a recession.

“We took this step to keep the economy strong,” said Powell during a press conference with reporters.

The federal funds rate, which controls the cost of mortgages, credit cards and other borrowing, will now hover between 1.75% and 2%.

Click here to read the full article:


Wall Street slides after Saudi attacks; energy stocks surge (Reuters)

Screen Shot 2019-09-16 at 9.16.46 AM(Reuters) – Wall Street slipped on Monday on global growth worries after the weekend attack on Saudi Arabian crude facilities knocked out 5% of the world’s supply, while a more than 10% jump in oil prices lifted beaten-down energy stocks.

The attack on the world’s biggest oil exporter sent oil prices up as much as 20% before they eased off their peaks as U.S. President Donald Trump authorized the use of the country’s emergency oil stockpile to ensure stable supplies. [O/R]

The S&P 500 Energy .SPNY, one of the worst performing sectors this year, soared 3.18%, its best day since Jan. 4.

Click here to read the full article:

Market Commentary: With the Yield Curve Fully Inverted, Is the Clock Ticking Toward Recession? 

MarketCommentary2016-croppedBy Sam McElroy, PsyD, NSSA
Tad Cook, NSSA

After hitting new record highs in late July, each of the major stock market indexes started August with a drop. The market regained some of those losses only to drop again the following week, then repeated the cycle as the month ended. While another escalation in the Trump-China trade war was partly to blame for the volatility, many other factors are likely to continue making Big Investors nervous that the next recession and major market correction may be just around the corner.

Shortly before the G7 Summit in mid-August, President Trump and Chinese President Xi Jinping both announced plans for more tariffs, and on the same day the Dow Jones Industrial Average dropped 623 points, while the S&P 500 closed about 6% off its record high.* More significantly, at around the same time, the US yield curve became fully inverted. While we have been discussing the significance of a flat or inverted yield curve for several years now, most of the financial media has only begun to pay attention to it recently.

It started making headlines on December 3rd last year when the yield on the 5-Year note fell slightly lower than the 3-Year note. But that was only the beginning. The inversion culminated in mid-August when the yield on the 10-Year Treasury fell below the 2-Year note, and the 30-Year bond closed below 2% for the first time ever.** The 10-Year yield was already lower than the Federal Reserve’s benchmark short-term interest rate despite the Fed lowering rates to 2.25% at its July meeting.

In a normal yield curve, short-term bills yield less than the long-term bonds, and investors expect a lower return when their money is tied up for a shorter period. When a yield curve inverts, it’s because investors have little confidence in the long-term economy. That’s why an inverted yield curve is said to be one of the most accurate indicators of a coming recession—and history bears out that accuracy. According to studies, an inverted yield curve has preceded every domestic recession since 1955.***

Will This Time Be Different?

Nonetheless, there are always some economists who make the argument that “this time will be different.” When the curve inverted prior the Great Recession in 2008, for instance, the Fed tried to explain it away by saying a “global savings glut” was pushing excess cash into US treasuries, driving down yields and creating an unreliable recession indicator.**** Obviously, they were wrong.

One of the arguments some economists are making for why this time will be different is that this inverted yield curve is not really being caused by a projected major slowdown in growth for the US economy, but by the global economic situation. Many countries across Europe also have inverted or partially inverted yield curves now, and even in countries where the yield curves aren’t inverted, such as Germany, interest rates are still in negative territory. Some economists say this is the real force pushing down US interest rates, more so than a slowing demand for goods and services that will trigger a recession.

While there is some merit to that argument, it overlooks a key point that we’ve made previously in this space: an inverted yield curve isn’t always just a symptom of recession; sometimes it’s a primary cause. The real damaging part of the inversion isn’t that investors have little confidence in the economy, but that banks and other lending institutions suffer real fiscal consequences when the yield curve inverts. With long-term interest rates lower than short-term rates, banks have to pay depositors more than they get back from borrowers. They lose their financial incentive to lend and end up tightening their underwriting standards and approving fewer loans. That affects home sales, car sales, business start-ups and a host of other areas crucial to economic growth.

So, with all due respect to those other economists, we disagree that “this time will be different.” At the end of the day, even if US growth were to remain strong but other economies around the world continued to struggle, we would ultimately feel the impact. Even if you’re the “cleanest dirty shirt” in the hamper, you’re still going to collect dirt off the other shirts. The bond market (which is said to be smarter than the stock market) knows this, and that’s just one reason why its most reliable recession warning signal—the inverted yield curve—is flashing red.

Ahead of the Curve

With all of this in mind, we believe we’re in a “sweet spot” right now for investors who haven’t yet reduced their stock market risk by switching their strategic focus from growth to income. Although the market has been volatile and trading sideways since early 2018, it still hasn’t started that major sustained drop that is likely to coincide with the next recession. There is still time to reduce your market exposure and avoid getting caught in the next downdraft. How much time? No one knows for sure, and the market may even eke out another new record high before the recession begins. But is it worth risking a major loss in hopes of getting a minimal gain?

As we mentioned in last month’s newsletter, the current environment also creates a good opportunity for Income Specialists to demonstrate why investing-for-income is a sound strategy regardless of market conditions. While overall low interest rates do make it challenging to get good competitive yields, rest assured that we and other advisors who specialize in active management are making the strategic adjustments necessary to meet that challenge on behalf of our clients. That’s the beauty of the income model: it isn’t based on crossing your fingers and hoping for growth; it’s based on real strategies that can be modified and amended to keep you ahead of the curve—even when the curve inverts!

*“Five Things to Know Before the Stock Market Opens Monday,” CNBC, Aug. 26, 2016

**“30-Year Treasury Yield Falls Below 2% For the First Time, CNBC, Aug. 14, 2016

***“Inverted Yield Curve and Why It Predicts a Recession,” The Balance, Aug. 27, 2019

****“This Time is Not Different for the Inverted Yield Curve, CNBC, Aug. 28, 2019