August’s Hot Recession Trade Is Cooling

Stocks are a hair’s breadth away from records and Treasury yields are soaring at a pace last observed years ago, a shift that investors say points to an unraveling of fear-driven bets that sent markets tumbling in August.

The yield on the 10-year Treasury note, which investors closely track because it helps set rates on everything from student debt to mortgages, is on course for its steepest one-month rise since January 2018. On Friday, the yield was 1.754%, compared with 1.469% at the start of the month.

There are other moves rippling through markets that typically point to confidence among investors. The S&P 500 is up 19% for the year and stands away 1.1% from its all-time high. Gains in bank stocks like JPMorgan Chase & Co. and Bank of America Corp. are more than triple the S&P 500’s gain so far in September And the most persistent indicators of a potential recession have eased in recent weeks. The extra yield that three-month Treasurys offer over 10-year Treasurys, for instance, has shrunk to the smallest level since early August. Historically, when bond yields and risky assets like stocks rose together, money managers bet that growth and inflation would pick up. Perhaps the most stark example of such a market shift was in the months after the U.S. presidential election in 2016—when optimism about a hefty fiscal-stimulus package promised by newly elected President


drove what investors called the “reflation trade.” Yet many investors doubt the moves this time around reflect an upbeat outlook. They instead believe the reversals coursing through markets now represent the walking back of pessimistic bets that roiled markets in August. After some reconciliatory gestures between the U.S. and China on trade and fresh setbacks for U.K. Prime Minister

Boris Johnson

’s Brexit plan, some of the worst-case scenarios investors had feared on the geopolitical front appear to have been avoided. That has made some of the one-sided bets that took hold of the markets in August look overdone, they say. “We’re not believers that we’re marching towards a big cliff in the markets,” said Michael Stritch, chief investment officer and national head of investments at BMO Wealth Management. But he said he doesn’t believe stocks are on the cusp of a huge rally, either.

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Mr. Stritch added that, since dialing back on some of its riskier positions over the summer, the firm has generally held a neutral position on stocks. He remains skeptical that the economy is on the cusp of a fresh breakout. Investors will get a look in the coming days at the Commerce Department’s final estimate for second-quarter gross domestic product. The report is expected to show the pace of growth slowed from the start of the year, but remained solid thanks to consumer spending. That would largely align with what many money managers and analysts said they already believe: that growth looks like it is neither slowing at a pace that suggests an imminent recession, nor poised to accelerate to the 3%-plus pace of prior quarters. A report at the start of the month showed the manufacturing sector contracted in August for the first time in three years. Yet the unemployment rate has continued to hover near a multidecade low, and consumer spending has remained strong. Commerce Department data released Sept. 13 showed retail sales rose 0.4% in August from the prior month, more than the 0.2% that economists surveyed by The Wall Street Journal had expected. Following the retail-sales report, Morgan Stanley economists raised their forecast for third-quarter gross-domestic-product growth to 2.1% from earlier estimates of 1.8%. “The whole discussion of recession has gotten way ahead of itself,” said Shawn Cruz, manager of trader strategy at TD Ameritrade. To Mr. Cruz and others, the market’s turn over the past month has been less about investors fundamentally rethinking the economic outlook and more about repositioning after the market’s tumult in August. The S&P 500 logged its steepest one-month decline since May that month, while the yield on the 10-year Treasury note posted its biggest one-month decline since August 2011. Now, markets appear to be in the midst of a similarly dramatic shift. Equity funds posted one of their largest inflows of the year in the first half of September, according to Deutsche Bank, while government-bond funds posted their biggest outflows in more than five years.

Meanwhile, many of the hardest-hit sectors in the stock market in August are among the best performers in September. Banks, manufacturers and energy producers—cyclical shares that tend to rise when investors are more confident about economic growth—have outperformed the broader market this month. That has been at the expense of technology shares, which had led the way throughout much of the bull market but are trailing the S&P 500 in September. “It’s not necessarily an all-rational move,” said Jon Hill, interest-rate strategist at BMO Capital Markets, adding that there had been some extreme positioning around bets on lower long-term rates over the summer. But there is no guarantee the trend continues at its current pace either, Mr. Hill said. Stocks briefly lost some ground—though they ultimately erased their declines—after Federal Reserve officials signaled Wednesday that there was division on whether they believed they would lower interest rates again this year. “There are a lot of concerning things over the next couple of quarters that markets are still going to have to deal with,” Mr. Hill said. Write to Akane Otani at

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