Today we’d like to refresh/update several data points we’ve been showing you in recent months and see what they have to say about current market and economic conditions:
#1: The difference between 3-month and 10-year Treasury yields, which is the basis of the widely watched New York Federal Reserve Recession Probabilities Model. This indicator is only really useful when one examines it across several cycles, so here is the data back to 1982, with gray recession bars for 1981/1982, 1990/1991, 2001, 2008/2009, and the yellow shading on the left for the present day Pandemic Recession:
Three points here:
- Whenever 10-year Treasuries yield less than 3-month paper (a proxy for Fed Funds rates), a recession is almost certainly at hand. While the Treasury market certainly did not call the pandemic or its economic impact in mid 2019 (that last dip below zero visible on the rightmost part of the chart), it was signaling that the US/global economy was slowing.
- With long term interest rates now beginning to rise, the 3M-10Y spread is widening, just as it has at the start of every economic recovery over the last 40 years.
- Do not, however, expect this indicator to go back to its old recovery levels of +3 points. With the Federal Reserve keeping rates at zero through 2021, 3-month Treasuries will be close to zero for a while. Seeing 10-year Treasuries go to 3 percent seems unlikely given continued Fed buying ($2.2 tn year-to-date, with further purchases every month).
Takeaway: while this classic recession/recovery indicator is clearly flashing an “all clear” sign, it is unlikely to give as full-throated an endorsement of future economic growth as it has in the past. That’s OK – we’ll take what we can get.
#2: The offshore Chinese yuan, which floats freer than the officially set rate, has strengthened 2.6 percent since the start of Q3, handily outpacing the 1.3 percent gains of the developed country currency components in the DXY index. As this 5-year chart courtesy of MarketWatch shows, the offshore yuan has actually been strengthening against the dollar since May (the second peak on the right of the chart) and is:
- Up 5.6 percent for the year against the greenback
- Sitting at +2-year highs
- Back to where it was in Summer 2016 (i.e. before President Trump was elected and started to pursue more aggressive trade policy)
Takeaway: there was a lot of buzz around the US election earlier this month that the offshore yuan was a proxy for the outcome (much as the Mexican peso was in 2016), but the data here shows the Chinese currency was already in strengthening mode back to May. Yes, a Biden administration may be more methodical in its efforts to address the US-China trade relationship. But even though we’re unlikely to get back to a status quo ante, the yuan is back to 2016 levels. To us, that indicates fundamental market confidence in the Chinese economy, a positive for global equities and especially Emerging Markets.
#3: European and US Financial stocks. The following 2010 – present chart shows the relative performance of the S&P 500 Financials sector (XLF ETF, in burgundy) and the MSCI Europe Financials Index (EUFN ETF, in blue).
US Financials have done relatively well over the last decade, up 135 percent on a price basis. They did hit a wall in 2018 (that first peak, about 2/3rds of the way across the chart) when the market’s hopes for a global synchronized expansion fell by the wayside. Early 2020 (the last peak) was a replay of that false dawn. Now that investors are more confident in a US economic recovery, US Financials are working once again.
European Financials are a whole different kettle of fish, actually down 20 percent on a price basis over the last decade. Negative interest rates, overcapacity, regulation, and slack economic growth have collectively held back this sector. Even the group’s recent bounce, +21 percent for Q4-to-date, only puts it back to 2011 – 2012 levels (i.e. during the Greek Debt Crisis, visible above as the period when US and Euro Financials first decoupled).
Takeaway: there has been an occasional sky-is-falling narrative around the European banking system over the last year that we’ve kept tabs on just in case it meant something. The truth is that the group has simply been a lousy investment. If there were more to the story, US Financials would not have doubled in the last decade. Still, it is good to see European banks and insurance companies rallying in Q4 as one more sign of investor confidence. But make no mistake: this is still a fundamentally weak industry.