For all the shine and sophistication, for all the jargon, algos, robots and quants, financial markets are still only this: Buyers buying and sellers selling, times a billion.
Behind every trade -- perhaps far behind -- there is an actual human person. Two, in fact. And because humans disagree a lot, markets do too.
And do they ever disagree just now.
The front line pits risky assets like stocks against the safest securities, namely bonds, and it’s there that the war is being fought now. The S&P 500 just had its best week since November. Yet in fixed income, Treasury yields are near the lowest levels in almost two years.
In the simplest terms, bonds investors are screaming recession, while equity and credit traders refuse to hear it. The contrast mirrors the macro outlook, which is caught between the prospects of a prolonged trade war derailing already fragile global growth, a sudden breakthrough that ends tariffs and dovish central bankers riding to the rescue.
“If you have been compressing equity prices with fear driven by a trade war, now you douse the trade wars with some nice cooling Fed-rate-cut water, then you can probably see a bounce on the other side of that and that’s a short-term story,” said Thomas Thygesen, head of cross-asset strategy at SEB AB. “The longer-term risks haven’t been settled.”
At first glance, it would be easy to say stock markets look overconfident. Every U.S. recession in the past 60 years was preceded by an inverted yield curve, and three-month Treasury bills currently yield more than 10-year notes. The S&P 500 remains within striking distance from its all-time high in its longest-ever bull market, but the gauge has slumped during recent slowdowns.
For Nuveen Asset Management’s Bob Doll, the relative robustness of the benchmark U.S. equity gauge isn’t so illogical. Speaking to Bloomberg TV on Thursday, he noted that underlying growth and earnings data in the world’s biggest economy is still OK.
“It’s not great, but it’s good enough,” the chief equity strategist said. “Sustained moves down only happen when you have a big economic problem. I think this choppy frustrating market is going to be around for a while.”
How long the data remain “good enough” is key. Bloomberg’s economic surprise indicator for the U.S., which had been trending upward since March, took another turn in the past few weeks. So far it hasn’t been enough to roil equities, and cyclical sectors have held up well against their defensive counterparts.
But the negative data surprises could continue. Non-farm payrolls on Friday missed all estimates in a Bloomberg survey, with employers adding 75,000 workers versus expectations for 175,000. It wasn’t bad enough to reverse the week’s stock rally, but it is suggestive of creeping pressure on the economy.
“We still see many markets overpricing global growth prospects,” James Bateman, the chief investment officer for multi-asset at Fidelity International, wrote in a note. “If trade wars or fundamental data deteriorate, we could see a sell-off.”
The one market not overpricing growth prospects is bonds. The yield on 10-year Treasuries has dropped in the past five days, after the biggest monthly decline since 2015. Europe’s benchmark, 10-year German bunds, closed at minus 0.257% on Friday, the lowest on record. U.S. bonds are in their own multi-decade bull market, and recent angst over the resilience of the world’s economy has helped give it a new lease of life.
Strategists at JPMorgan Chase & Co. said this week that the drop in yield for five-year U.S. notes since November pointed to a 53% probability of a recession in America. They put the odds implied by stocks and junk debt at 17% and 1%, respectively.
But there are a couple of reasons these divergences may not be as irreconcilable as it seems.
One thing the rates market also suggests is that there’s little ahead to quash traders’ confidence that the Federal Reserve will cut rates as soon a July, with Fed funds futures showing a quarter-point reduction almost fully priced in for next month.
A lurch to dovishness can support risk assets, as it helps growth and makes their returns relatively more appealing. In places like Europe, policy makers are seen as having little room to cut rates, so the word “stimulus” is once again appearing -- another fillip to many assets.
Second, the dash into the safest debt -- some $17.5 billion flowed into bond funds in the week through June 5, the second largest inflow on record -- has dramatically driven up the world’s stockpile of negative-yielding securities, which topped $11.5 trillion this week. That sends some investors in search of returns, which supports demand for riskier assets.
In the credit markets, for example, investment-grade funds recorded a record inflow of $12.3 billion through June 5. For all the angst about the economy, the average spread of junk-rated U.S. bonds remains well below the 2016 high as well as the five-year average.
Yet once again, the messages are mixed. Outflows from the high-yield portion of the market continued for a fifth week, and a key gauge of trading conditions in riskier bonds is close to reprising levels seen in the December rout.
Small wonder gold had its best week since April 2016 -- the bears are digging in. Meanwhile, swap markets show inflation expectations falling in the U.S. toward the lowest in more than two years and in Europe to below levels seen in the crisis. That suggests bonds can keep rallying. Commerzbank AG said on Thursday it’s forecasting the benchmark U.S. yield will fall to 1.25% by year-end, a record low.
For some analysts, the gloom is too extreme. Bank of America said that, combined with dovish central bankers, it could all mean another stocks record is on the way.
“The market is a bit split, a bit unsure actually where we are,” said Caroline Simmons, deputy head of the U.K. investment office at UBS Wealth Management. “Our view is that we are in the early parts of the late stage of the cycle, which is the environment that actually tends to do relatively OK for equities because you’ve usually got growth that’s still good, which it still is although patchy, and you usually have supportive monetary policy.”