And How Many Aboard, Mr. Murdoch? – Oct 27th 2023

Pain continues to make its unwelcome rounds in the global market scene, with geopolitics stealing the spotlight. Last week, the Fed left us with a gentle dovish note as they entered their period of market silence until November 1st. The Bank of Canada (BOC) and the European Central Bank(ECB) have paved the road for the Fed with their “no-action” prelude. The upcoming Fed decision might not set off fireworks, but all ears are tuned to the press conference for potential surprises. Why now you ask?

September’s data painted a sunny picture for the U.S. consumer, splurging on homes and self-indulgence. Yet, let’s not forget that markets are forward-looking, and the tumultuous past month hints at a different October narrative. Cracks in the economic façade are becoming visible, with the recent earnings season and corporate guidance exposing vulnerabilities across various sectors. We even witnessed some market heavyweights stumble, nudging the S&P into a technical correction zone. Subtract the dominant Mag7 from the S&P, and we’re left with a single-digit loss for the year.

Short term correlations between asset classes have unraveled as well, leaving them to navigate alone through the these erratic markets. Not great news for those holding 60/40 portfolios, unless the “40”happens to be in cash or short-term debt instruments (see below).

The heavy sell-off of U.S. treasuries from overseas, coupled with a wave of new issuances looming in November, begs the question: why is there no “war premium” embedded in asset prices given the global circumstances? The 10-year and beyond section of the yield curve seems to have lost its allure.

So, what’s the magic recipe to restore investor confidence before we hit the elusive “BUY” button?

Behind door #1: Higher yields (for the belly and long end of the curve), in fairness, we’re not far from reaching average historical term structure levels (in 2y10y, 5y30y, 10y30y). Assuming, no exogenous shock or event, a 10yr at 5/5.25 and a 30yr at 5.75/6.00 should be manageable for a sustained period of time.

Behind door #2, there’s the less-than-thrilled Joe – and no, we’re not diving into political waters. I’ll explain through a figurative illustration: Picture a 500 lb weight, stamped with J. Powell’s seal, tethered to a string, cast into the deep sea. How long is the line, and what’s on the other end? Bingo! It’s your average Joe and favorite U.S. consumer. Well, that line is now tight and Joe finds himself in troubled waters, a scenario that should start to become evident in next month’s data. And what if it’s not Joe at the other end? Well, history teaches us that the line simply snaps and Joe will still foot the bill. Thanks, Joe!

Indeed, in either scenario, there’s a rescue act waiting in the wings. Choose #1 and #2 will occur sooner. Current market sentiment is grim but the 2y10y spread has nearly leveled out to zero (what’s -20bps these days anyhow?), but it’s typically a sign that the worst is behind us. And whether you’re a fan or not, the U.S. economy is currently shining brighter than any of the alternatives. Keep the BUY button close and listen out for the rescue sirens!