Who is the Real Cassandra - July 2019
Greek Mythology’s popularity spread through Homers’ works, the Iliad and the Odyssey. (1) However, Hesiod deserves credit for establishing the original structure in his poem, Theogony, written around 700 BC. (2) Think of this as an early version of 23 and Me, documenting the ancestry of all Greek characters. Despite being both ﬁctitious and ancient, many aspects of Greek Mythology continue to be referenced today.
One such story involves Cassandra, daughter of Priam, the King of Troy. Smitten by her beauty, Apollo, the son of Zeus, bestowed upon her the gift of prophecy. When Cassandra rejected Apollo romantically, he placed a curse on her that would make her predictions non-believable to others. Cassandra could see the future, but nobody would heed her warnings. In 1949 a French philosopher coined the phrase, “Cassandra Complex” to capture the idea of ignoring cautionary signs.
Today the bond and stock markets are ﬂashing conﬂicting signals. Could one of them be a Cassandra?
The Bond Market
Does the bond market have credibility? Consider “the players” depicted in the chart below. (3)
Not exactly slouches. The most liquid market on earth trades about half a trillion dollars daily. It expresses opinions in two ways: the shape and the direction of the yield curve.
The shape entails the difference between what an investor can earn on a 10-year Treasury and something short, such as a 2-year. Intuitively, one would expect a higher return for committing capital for 10 years rather than two years. That gap tends to shrink during periods of economic uncertainty. The following graph shows the yield differential currently approaching zero (the yellow highlight); not quite technically inverted, but close. The periods when it has gone below zero have strongly coincided with economic recessions, as indicated by the vertical gray bars. (4)
The direction of interest rates supports the interpretation above. The 10-Year Treasury Note peaked at about 3.0% last October (coinciding with a severe stock market correction). By June 30th rates dropped 50% to 2.0%. (5)
The Stock Market
Candidate #2 for possible Cassandra is the stock market, tipping the scales at an impressive $30 trillion in total size.(6) The major participants look similar to the bond market, except there are fewer foreign holders (15% vs. 36% for Treasury Bonds) and more individuals (34% vs. 13% for Treasury Bonds).
The stock market (7) speaks only with direction. The chart below (8) captures the signiﬁ cant downturn in the equity markets that occurred between October and December of 2018 and the roaring rebound off those 12/24/18 lows. Looking only at this calendar year one can’t help but think “Let the good times roll.” (9)
The S&P 500 serves as one of the ofﬁ cial Leading Economic Indicators used by the Conference Board to gauge the ofﬁcial status of the economy. (10) The upward trajectory of the stock market, quite evident in 2019, augers well for the economy.
The Race Tightens
So, is the economy slowing as the bond market suggests, or heading for glory days per the stock market? Are one of these our Cassandra? Both? Neither?
Let’s thicken the plot with some additional info. “Urban myth suggests that the bond market is smarter than the stock market and is sometimes a more stable, reliable metric.” (11) This seems plausible. After all, the value of the companies in the S&P 500 most likely were not worth 23% less on Tuesday October 20, 1987 than the day before. (12)
• Credit spreads, the yield on lower quality bonds in excess of the yield on Treasuries, denote investors’ risk tolerance. The current 2.3%, spread, near 2-year highs, suggests a waning appetite for risk. (13) The credit markets must be singing from the same sheet of music as the bond market and contradicting the stock market.
• Consumer Conﬁdence fell to 121.5 in June, nearly a 10-point drop from 131.3 in May and the index’s lowest level since September 2017. (14) Lower conﬁdence tends to lead to stingier purchasing habits.
• ISM Manufacturing Index fell to 51.7 in June from 52.1 in May and is down for three consecutive months. (15) Readings below 50 are associated with a contracting economy.
• Employment increased by 224,000 in June, better than expected. The unemployment rate was little changed at 3.7 percent. (16) More hiring creates more wages and eventually spending. Two-thirds of all U.S. economic activity (GDP) stems from the consumer.
These indicators provide mixed signals. Credit spreads, consumer conﬁdence and manufacturing all support the bond markets’ interpretation of a slowing economy. Employment ﬁgures look strong and help to ease any concerns of stock investors.
Before decreeing either the bond or stock market as today’s Cassandra, we must consider some decoys. Trade tensions complicate the manufacturing sector, raising prices on strategic materials, disrupting supply chains and raising uncertainty. This could explain both the weak ISM ﬁgures and diminished consumer conﬁ dence. Interest rates remain artiﬁcially driven to near historic lows; inﬂ ating asset values.
Hung jury. The bond market telegraphs a slowing economy. The Fed, as seen in the following graph, forecasts GDP growth dipping back below 2.0%, after getting some juice from last year’s tax cuts. (17)
The sturdy stock market might not be explicitly rejecting this thesis, instead, looking forward by 6-9 months, focusing beyond the slowdown. REO Speedwagon might describe the stock markets’ view as “Riding the Storm Out”. Here are three possible reasons for their optimism.
Reason #1: Mortgage rates spiked at the end of 2018, causing a slowdown in the housing market. The chart below (18) shows that mortgage rates have backed down this calendar year, from about 4.5% all the way to 3.75%, enhancing affordability in the housing market.
Reason #2: The trade tensions, though difﬁ cult to handicap, seem likely to get “resolved” before the next election. Even if the tensions continue, supply chains will eventually be rebuilt.
Reason #3: TINA. Not Tina Turner, nor Tina Fey. TINA is an acronym that stands for “There is No Alternative” and refers to stocks being the only investment option for staying ahead of inﬂation.
A more cynical view could be that the stock market prefers low interest rates over a strong economy.
According to lore, Cassandra warned the Trojans to “Beware of Greeks bearing gifts”. Unfortunately for the people of Troy, she was ignored, “The Trojan Horse” was allowed beyond the wall, triggering the destruction of Troy. At some point the ﬁnancial markets might regret the gift of exceedingly low interest rates. However, for the past 10 years a slowly growing economy, coupled with cheap debt has resulted in a generally rising stock market. We accept this reality but have no illusion that today’s benign conditions are permanent; or that the longer-term risk associated with higher valuations has been eliminated.
1. “Odyssey by Homer”. Naomi Blumberg. Encyclopedia Britannica
2. Hesiodic Theogony. Translated by Gregory Nagy. Center for Hellenic Studies, Harvard University
7. Our reference to the “stock market” is meant to be the S & P 500
9. “Let the good times roll”. The Cars; 1978
11. Bob Johnson, Morningstar’s director of economic analysis. “Is the bond market still smarter than the stock market?” MarketWatch.com; Nov 18, 2016
12. The S & P 500 dropped a record 22.6% on “Black Monday”; October 19, 1987
13. St Louis Federal Reserve Bank. https://fred.stlouisfed.org
14. “Consumer Conﬁdence Slid in June on Trade Tensions”. Wall St. Journal; June 4, 2019
15. “U.S. Factory Activity Slips Again”. Wall St. Journal; July 2, 2019
16. “THE EMPLOYMENT SITUATION — JUNE 2019”. Department of Labor; July 5, 2019
17. Atlanta Fed GDPNow Estimate for 2019: Q2. Federal Reserve Bank of Atlanta; July 3, 2019