Thursday , 2 April 2020


These 13 Market-based Indicators Are Looking Good!

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I’m a big fan of market-based indicators…[which] can be viewed in real-time and reflect how “the market” interprets all the information currently available…[as opposed to] traditional economic indicators (e.g., payroll employment, GDP, CPI) that come out with a lag, are subject to revisions, and are based on assumptions that do not necessarily reflect the reality on the ground. [This article presents 13]…charts that show the status of the market-based indicators that I believe merit ongoing scrutiny.@A Financial Site For Sore Eyes & Inquisitive Minds

Chart 1: Real Yields vs. Yield Curve Slope

…[As noted in the chart below historically] every recession has been preceded by a substantial rise in the real funds rate (and a substantial increase therefore in real borrowing costs) and a flat or negatively-sloped yield curve. Today, those conditions are nowhere to be found. Real borrowing costs are historically low, and the yield curve is not inverted…[which] means that the Federal Reserve’s monetary policy poses no threat to the economy. It would be fair to say that the Fed’s current monetary policy stance is broadly neutral. @Economic Developments

Chart #2: 5-yr. Nominal vs. Real Yields
[As the chart below shows,] the market expects inflation, at 1.6%, will be below the Fed’s upper target [of 2.0%] so there is no indication that the market is worried about the Fed being too easy, and that is the one thing I would really worry about, since that would pose the specter of a tighter Fed to come and a likely recession to follow.

Chart #3: 5-yr Yields vs. Overnight, Risk-Free, Real Yields
…[The chart below shows that] the market is not expecting the Fed to do anything that might jeopardize the economic outlook. Indeed, the market currently expects the Fed to lower rates at least once in the next year or so, and then to keep rates flat. From several perspectives it is clear that the Fed does not pose a risk to markets or the economy. Thank goodness! @Follow the munKNEE

Chart #4: 2-yr. Swap Spreads
At current levels, the chart below shows…us that liquidity both here and in the Eurozone is abundant – central bank monetary policy is non-threatening, to say the least. This further suggests that the outlook for the global economy is healthy, and systemic risks are low.

Chart #5: 5-yr. Credit Default Swap Spreads

…[This is] an excellent proxy for the market’s confidence in the outlook for corporate profits and the current relatively low levels [as shown in the chart below] imply that the market is not concerned that profits will disappoint. That, in turn, would imply a favorable economic climate in the years to come.

Chart #6: Corporate Credit Spreads

…[The chart below] shows that the market is relatively confident regarding the future health of corporate profits.

Chart #7: 10-yr. Treasury Yields

In contrast to the preceding charts, which paint a picture of optimism regarding the future, Chart #7 below reflects a lot of concern regarding the future.

…The market is generally optimistic about the future, but at the same time there is intense demand for an asset that can hedge against the possibility of that optimism proving wrong. The market is optimistic, but unwilling to throw caution to the wind. That’s healthy. The time to worry, of course, is when everyone expects the future to be rosy and no one is concerned enough to hedge their risks. That was the case, by the way, in late 1999 and early 2000, when PE ratios were on the moon and real yields were trading in a range of 3-5%.

Chart 8: 2-yr. to 10-yr. Treasury Spread 

…[As can be seen in the chart below] the curve has only a modest upward slope, but nevertheless one that is consistent with conditions in the mid- to late-90s when the economy was growing at a healthy pace. As Chart #1 reminds us, a flat yield curve is not something to worry about unless real yields are also relatively high.

Chart #9: 10-yr. to 30-yr. Treasury Spread

…[The chart below shows] that the curve has a very normal upward slope. Nothing alarming here at all.

Chart #10: Savings Deposit Growth

[The chart below] shows the 6-month annualized rate of growth of bank savings deposits, which comprise almost two-thirds of the M2 money supply and, since these deposits pay little or nothing in the way of interest, the growth in these deposits is arguably a good proxy for the world’s demand for safe-haven “money.”

…[The chart above shows] a sharp increase in the rate of growth of the safe harbor of bank savings deposits over the course of last year at a time when the world became quite worried about the possibility that Trump’s tariff wars could lead to a big slump in global economic activity…This is very similar to what happened to the demand for 10-yr Treasuries in the past year: demand proved so strong that yields fell to extremely low levels.

Chart #11:  S&P 500 Returns Compared to the VIX/10-yr Treasury Yield Ratio

This ratio is a good proxy, I would argue, for the market’s level of fear, uncertainty and doubt about the future. Increases in this ratio have usually been accompanied by falling stock prices and vice-versa. Today, concerns are ebbing and stocks are once again rising.

Chart #12: S&P 500 P/E Ratio

PE ratios are above average today, but they are still well below the extremes they reached in early 2000. Earnings per share today are 175% above the levels of 2000, but equity prices are up only 125%. This is not necessarily a bubble.

Chart #13: Equity Risk Premium

…PE ratios must be taken into consideration relative to the yields on risk-free Treasuries in order to judge valuations. 10-yr Treasury yields were north of 6% when PE ratios hit 30 in late 1999, whereas today they are 1.6%…Today that spread is almost 3%, whereas in late 1999 it was -3%.

Back in the late 90s the market was extremely optimistic about stocks and the economy…[but] today, the market is far from those levels of optimism. Indeed, equity investors demand an unusually large yield premium to hold equities instead of rock-solid-safe Treasuries.

Conclusion

This is not the stuff of which bubbles are made. My overall interpretation of the above indicators is that the economic and financial fundamentals look sound and [that], although risk asset prices are high from an historical perspective, they are not high in relation to other variables, and they are under-girded by a healthy degree of skepticism and caution.  There is still a lot of caution priced into the market. If the outlook brightens, there is plenty of upside for equities.

Editor’s Note:  The above excerpts from the original article by Scott Grannis have been edited ([ ]) and abridged (…) for the sake of clarity and brevity.  The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.  Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.

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