From the standpoint of finance theory, Wile E Coyote of the Warner Brothers cartoons reaches a point of minimum volatility just before he realizes that he has stepped off a cliff and is about to plummet to the valley floor a mile below.
Ben Bernanke last year warned that the US economy might be in a “Wile E Coyote moment,” suspended in mid-air by the temporary effect of the Trump tax cuts and ready to enter free-fall. After two months of motion that barely qualifies as Brownian, US markets have a very heavy feel.
Stocks are stuck in a range defined by a shrinking numerator (lower economic growth and lower expected profit growth) as well as a shrinking denominator (lower bond yields). The 10-year US Treasury yield has fallen from 3.23% in early October 2015 to 2.62% today, a plunge of 60 basis points, while the German Bund yield has fallen almost 50 basis points, from +0.5% to -0.05%.
The central banks put their fingers into the electrical socket in early 2018, and back-pedaled vigorously at the end of 2018, assuring the markets that they would do nothing at all during the course of the year.
That has left markets stuck in a trading range. Every Wall Street economist is dissecting the data for indications of further deterioration or so-called green shoots of recovery.
A number of indicators have been falling off cliffs during the past several weeks.
The first is world trade:
Another is the Global Manufacturing Purchasers Manager Index as compiled by JP Morgan:
A third is the six-month average increase in nominal US retail sales (excluding gas and autos):
It’s hard to envision a source of economic improvement.
1) The US-China trade war has reduced CapEx plans around the world as major corporations wonder where supply chains will be located, and US companies are spending more money to buy back their stocks than they are on capital investment.
2) US consumers are cautious about spending the 1.6% increase in real wages they received during 2018, while employers in labor-intensive industries can’t afford to pay enough to attract workers;
3) The descent of German Bund yields into negative territory persuades Germans and other Europeans to save rather than spend (to compensate for lower income on savings instruments;
4) There is no consensus in any of the larger European economies about how to undertake a fiscal stimulus.
Everything isn’t going off a cliff, to be sure. A number of key economic variables simply are stagnating. New home sales in the US remain stuck in the range of the past two years. As the chart below makes clear, lower mortgage rates during the fourth quarter of 2018 help explain the stabilization of home sales.
As long as the Federal Reserve and the European Central Bank maintain an accommodative stance, corporate credit, emerging market credit, real estate and other assets offering high-quality yield should continue to do well. I continue to believe that risk-reward favors cowardice in the present market.