Last week, the bond market fired a warning shot that sent the Dow Jones Industrial Average down 800 points in its worst session of the year.
Investors were freaked about what the inversion of the yield curve — the yield on the 10-year U.S. Treasury TMUBMUSD10Y, +2.23% briefly broke below the yield on the 2-year TMUBMUSD02Y, +4.04% — means for the economy.
But Vincent Deluard, global macro strategist at INTL FCStone, says there are much more important factors at play in this climate.
“As Confucius said ‘when the sage points at the moon, the fool looks at the finger,’” he wrote in a recent note to clients. “Journalists and traders who are obsessing about [the inversion] should attempt to look beyond the finger.”
With that in mind, he listed five “broken things” things we should be more focused on in this turbulent market than what the yield curve is doing.
Facebook FB, -0.02% , Apple AAPL, +1.04% , Amazon AMZN, +0.97% , Netflix NFLX, -0.52% and Google’s parent Alphabet GOOG, +0.65%, long the leaders of this relentless bull, rally have been underperforming the broader market and breadth divergences are spreading.
“This break in leadership is all the more concerning as U.S. small caps have lost about 13% since their peak last August,” Deluard wrote. “Similar divergences were also observed before the September 2000 peak.”
The FAANG stocks, he points out, account for 17% of the total capitalization of the S&P 500, so, without their support, the market’s upside is limited.
“As is frequently the case at major tops, the bull market is hollowing from both ends,” he wrote. “Small caps are underperforming as investors’ worry about the economic outlook, and the ‘narrative stocks,’ which fueled the rally, act tired.”
The U.S. dollar
There hasn’t been much upward movement for the dollar on the days the stock market has sold off, with investors instead looking toward gold GC.1, -0.07% and the yen USDJPY, +0.39% as the favored risk-off assets.
“This confirms my belief that the U.S. dollar is losing its status as a safe haven currency,” Deluard said, adding that, in fact, “the U.S. dollar index DXY, +0.11% has not been a good safe haven since 2013.”
Typically, there’s a big spike in the CBOE Volatility Index VIX, -8.74% when the Dow craters like it did last week, but that wasn’t the case.
“There is not enough fear in the market to suggest that Wednesday was the sentiment washout that could help build a sustainable rebound,” Deluard said.
The leveraged loan market is showing signs of stress, he wrote, as outflows have caused large loan ETFs to trade at discounts to their net asset values.
“The recent collapse of several high-profile European debt mutual funds is a warning that these illiquid securities can create havoc in unexpected places,” Deluard explained. “ETFs, which offer intraday redemptions, will be particularly exposed if the liquidity of the loan market dries up.”
Gold GLD, -0.39% and long-term Treasurys are both in a bull market and more correlated than ever before, he said. And that means, according to Deluard, “investors are finally pricing a prolonged period of financial repression and forced negative real rates.”