Since my last post markets climbed to hit new all time highs before suffering a sharp but relatively shallow correction. When the market was at its all time high there was little celebration with the exception of Trump on twitter. Equity fund flows continued to be generally negative/flat. There was a bit of complacency in the put/call ratios and some measures of sentiment like Investor's Intelligence and AAII sentiment did perk up a bit but no signs of the type of high complacency we saw in early 2018 which ultimately led to a 20% drop in the stock market.
Let's look at what triggered this correction. It was once again Trump induced via a slapping of additional tariffs on China. It's arguable as to the exact impact of the "trade war" but from what I can see it's going to end up being a fugazi, i.e. a red herring, i.e. it's not going to matter much when all is said and done. Ask yourself what has been the main drivers of the US economy? Trade with China would have to rank low on the list. This bull market has not been driven by US consumers buying cheap goods from China nor will it ever be.
Look back to what caused US recessions in the past - they were home grown issues that were at the heart of the US economy. They were credit crunches mainly due to housing downturns with an notable exception in 2000 which was due to a tech boom gone bust. In 2015/2016 when the energy sector had a major downturn, that was a good example of something that could have caused a recession since it was a notable sector in the US economy, but it didn't because it turned out not to be a large enough sector to infect the broader economy plus lower energy prices was a boon for consumers and non-energy businesses. It seems highly unlikely to me that any fallout from Chinese trade wars would be large enough to derail the US economy because it simply is not large enough to matter. What it does do is create angst, uncertainty and hesitancy which results in these types of corrections. This trade war may delay capital spending to some degree but I doubt it will be material enough to matter.
Throughout these past 10 years we have seen all sorts of worries/problems that made everyone fret. For instance in 2010 it was PIGS, in 2011 it was Moody's downgrade of US government debt, in 2013 it was the taper tantrum, in 2015/2016 it was energy. Ultimately, none of these things mattered much because they were not material enough to derail growth in the US economy.
Remember all the worries last year about the $4 trillion corporate refinancing tsunami that was to set to hit starting 2019? Well, thanks to plummeting bond yields, corporations and consumers are be able to refinance at quite favorable terms...and they can thank the pessimists for that! Higher interest rates were a headwind in 2018 and they are now a tailwind in 2019.
So far this recent drop in the market appears to be wiping out the green shoots of complacency that I mentioned previously. Put/call ratios are soaring and the VIX has notably spiked. Let's see how AAII sentiment turns out this week. History suggest AAII bulls will be running for cover. It's always difficult to pinpoint the ST direction of the market but so far this has the look and feel of a correction, not something nastier.
A few comments about bonds. They are currently at the most overbought level since July 2017 if you look at how far below the 10 year yield is from its 200 DMA (33% below!). At the very least this suggests bond yields should be close to a medium term bottom and maybe even a long term bottom. Sentiment and fund flows for bonds also confirm this. A year ago everyone hated bonds and there were no "experts" recommending investors buy them as the expectation was for higher interest rates. Now everyone seems to think that US bonds are a bargain even with the 10 year at sub 2% because of the $14 trillion in negative yielding bonds out there. Always remember the motto of this blog...I will be looking to buy puts on TLT soon.
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