A Tough Week For Equities

Markets gave back gains from the prior week’s rally on fears of rising US/China trade tensions, Brexit concerns and weaker-than- expected macroeconomic data. The MSCI World Index lost -3.69% while the S&P 500 lost -4.55%. The 30-year Treasury rate gained 3.82%, as the generic yield fell to 3.14%.

Huawei

Huawei is a Chinese state-owned telecommunications company. They are currently competing for dominance in 5G, the next generation of wireless connectivity. 5G wireless internet technology uses a part of bandwidth that can transmit a lot of information over a shorter distance. It would allow you to access the internet about 10x faster than 4G. Near real time communication between devices will allow you to potentially stream HD movies or empowering technologies like self-driving cars.

The US was the leader and primary beneficiary of 4G technology. International companies and countries are looking to capitalize on the 5G roll out. Countries are considering banning or limiting use of Huawei 5G infrastructure as they are concerned that Huawei posed a security risk since it lacks independence from the Chinese government. US/Chinese trade relations were strained last week when Wanzhou Meng, the CFO of Huawei, was arrested in Canada over US concerns that Huawei was violating US sanctions on Iran.

Brexit

Theresa May pulled the vote on Brexit on Monday after the significant pushback from Parliament last week. The proposed compromise has left lawmakers in both the ‘Leave’ and ‘Remain’ camps dissatisfied.

Macroeconomic Outlook

Weaker than expected global macroeconomic indicators weighed down global markets. In the US, higher-than-expected initial jobless claims and weaker non-farm payrolls disappointed. Japan missed on both the year over year capital spending. Canada was a bit of a bright spot for the week, where net change in employment was expected to be 10.0K but ended reporting a 94.1K gain.

Bond Market Rally

Weakness in the macroeconomic outlook of countries coupled with geopolitical uncertainty caused a spike in long term bond prices. As uncertainty increased, we are seeing investors in the bond market buy longer-term fixed rate securities. That is a signal that they believe interest rates will drop in the future. Whether that turns out to be true is uncertain.

The chart below shows the Treasury yield curve (the interest rate you would expect to receive for buying a Treasury) over the next 30 years. In a healthy economy, we would expect to see higher yields for longer term loans (the line would go up and to the right). When we see the line go to down and to the right, we say the line is ‘inverted.’ This can be a bad sign as it means there are many investors trying to lock in long term rates. That high demand is driving up the price of those bonds (higher prices mean lower yields).

You probably noticed that the 2-year is higher than the 5-year Treasury yield. That is what has concerned a lot of people in the market. While that is a bit concerning, we typically look at the spread between the 2-year and the 10-year rates. When those are inverted, historically, a recession has occurred within the next two years.

Investors are clearly becoming concerned about the flatter and partially inverting yield curve, but we would note that other factors such as unprecedented global quantitative easing (QE) are also at play in this environment.

Conclusion

The recent escalation in the trade war is a real concern. From the US perspective, the arrest of the Huawei CFO may be independent from the agreed upon tariff détente. However, China is clearly viewing this as a provocation that could derail talks.

While the recent inversion of the 2-year and 5-year rates have caused some concern, there is not a strong correlation between them and a slowdown. Panic associated with this may be overstated.

Increased likelihood of a hard Brexit could spell trouble for the UK and, to a lesser extent, Europe. The deadline is in March. These negotiations tend to get resolved in the 11th hour as there appears to be a desire to (or at least appear to) get the best possible deal. Unfortunately, we are in a wait and see phase of both sets of? negotiations right now. We are continuing to monitor these situations for potential risks or opportunities.

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