Have you ever gotten that feeling that something isn't as good as you think it is -- or at least like to think it is? Well, we're getting that feeling with the stock market due in large part to what has been happening in the Treasury market.
Consider these facts for a second: the S&P 500 gained as much as 16.5% from the December 24 low; the Nasdaq Composite gained as much as 19.7%; the Dow Jones Industrial Average gained as much as 16.7%; the S&P Midcap 400 Index gained as much as 19.2%; and the Russell 2000 gained as much as 20.3%.
Those are huge gains, but remarkably, the Treasury market has barely batted an eye at the move. If anything, it has been eyes wide shut, evidenced by the fact that Treasury yields, from the six-month T-bill to the 30-yr bond, are either flat or lower from where they were on December 24.
In other words, the risk-on trade in the stock market has not been corroborated by the Treasury market, which remains underpinned by risk-off trading behavior.
Ironically, the disparate performances are grounded in the same reality: economic growth is slowing.
The difference is that the stock market is expressing a bull-headed sense of relief that the slowdown isn't a recession, whereas, the Treasury market is expressing its bull-headed belief that a slowdown is still a slowdown.
In either case, inflation should be subdued, which also means central bank tightening action should be subdued.
Sure enough, central banks across the globe have been exhibiting newfound "patience" when it comes to tightening and newfound conservatism when it comes to GDP growth forecasts. Both the stock market and the Treasury market have behaved accordingly in response to that pivot.
At some point, though, their parallel universes are going to collide, because they can't both keep going up on the same economic reality. That's where the uneasy feeling sinks in with the stock market.
Back to the Future
We published an article in this space last October entitled, Don't Mistake the Stock Market for the Economy.
It is fresh on our mind today, and it bears repeating knowing the stock market has been turbo-charged by the idea that the Federal Reserve sounds content to sit on its hands for some time.
Our concluding thoughts in that piece were as follows:
"Just to be clear: bad economic news is not good news. It could translate to good things for the stock market for a while, however, which recognizes bad economic news just might convince the Federal Reserve to take fewer steps on its rate-hike path.
The stock market, though, needs to be careful with what it is wishing for. Bad economic news that keeps repeating itself will lead to downward earnings revisions that keep repeating themselves.
That's not a strong foundation on which to build a bull market. Rather, it is grounds to tear one down."
The stock market had a little setback this week, but it was by no means torn down. Nevertheless, its foundation was weakened with downward earnings revisions.
According to FactSet, the first quarter consensus earnings growth estimate is (1.7%). It was (0.8%) at the end of the prior week and 7.1% the day we posted the aforementioned column in October. The calendar 2019 consensus earnings growth forecast, meanwhile, is now 5.0%, versus 5.6% at the end of the prior week and 10.5% at the time of our October column.
Incidentally, the yields on the 2-yr note and 10-yr note at the time of our October column were 2.84% and 3.14%, respectively. Today, they stand at 2.45% and 2.63%.
What It All Means
The Treasury market is marching to the beat of a slowing global economy. The stock market, though, is marching to the beat of a different drummer. It is loving bad news that holds interest rates down while ignoring the drumbeat of downward earnings revisions.
Investors can't turn a blind eye to those estimate revisions forever, because they will be the breaking point of a market that gets overvalued in a weakening economic environment.
That's why it is prudent to take some profits from a rally that has been gifted to the equity market by the Federal Reserve. That gift, though, is wrapped up in concerns about the economic outlook, which are also showing up in other sovereign bond markets.
For example, the yield on the 10-yr German bund, which stood at a lowly 0.25% on December 24, is at a lowlier 0.08% today. The 10-yr Japanese government bond yield, which stood at 0.03% on December 24, is now at -0.04%.
There is something that just doesn't feel good about those indications, yet investors don't need to look that far to feel unsettled.
They can look at the U.S. Treasury market, which is acting as if the economic environment isn't going to get any better, and giving the stock market a warning signal that bad economic news will translate into bad earnings news that doesn't warrant further multiple expansion.