Executive Summary
1. The consumer is healthy, and don’t fear the curve. The U.S. consumer is healthy, with real personal disposable income growing above the trend of the last several years, and in line with long-term trends. Data suggest that a sharp decline in personal income growth occurs before the onset of a recession, and we see no evidence of that yet. That is one more contextual piece of evidence that the “yield curve inversion” trumpeted by financial media on March 15 is not a sign that recession is imminent. The best and broadest measures of financial conditions in the U.S. continue to show no stress — that is, no sign of the imminent shutdown of credit that would tip the economy into recession. And remember: the initial inversion of the yield curve usually signifies not that a bull market is over, but that it is about to accelerate into its ultimate peak.
2. Data storage in DNA. Microsoft announced a step in its effort to stave off what it views as a looming crisis of data storage capacity. Ubiquitous devices and the Internet of Things are generating vast amounts of data, leading to a search for next-generation storage media. Investigators hit on the idea of molecular storage, in which data are translated into DNA molecules, which has the potential for an enormous increase in data density, as well as the prospect for more robust and less easily degraded storage. Microsoft collaborated with the University of Washington to automate the process, and announced their first success in the journal Nature.
3. Market summary. Our investing attention remains focused on the United States, China, and some emerging markets (“China’s workshops”). After the decline of the last quarter of 2018, U.S. stocks posted the best first-quarter performance since 1987, and global stocks the best since 2010 (in the flush of the global economy’s exit from recession, and the Chinese government’s enormous economic stimulus program). While worry persisted about global growth during the first quarter, investors have begun to look ahead past a bottom of negative data and towards the reacceleration that we have been suggesting was in the cards since last year. Chinese data have begun to turn positive — such as the purchasing managers’ index (PMI) data released on Monday. Chinese investors are borrowing to buy stocks. U.S. investors, for their part, have more cash to put to work in stocks; U.S. money market assets are near their highest levels in eight years. In brief, we are bullish on the U.S. and emerging markets, and bullish on China. Within the U.S., we favor big cap tech, but prefer those that are not facing imminent scrutiny from regulators and public opinion. Once Brexit is concluded, Europe may experience a relief rally; as we have often noted, while Europe has deep, unresolved problems, political and economic events can sometimes conspire to create a trading opportunity.
Personal Income Is Up, Which Correlates With A Stock-Market Rally
The health of the consumer is one of the key drivers of the U.S. economy, given the preeminent importance of consumer demand (and of course, this is a feature of all developed economies, not just of the U.S.). Real personal income is the basic driver, which depends on both income growth and cooperative, quiescent inflation trends.
Consumers Have Reason to Cheer, and So Do Investors
The Bureau of Economic Analysis (BEA) just published February data for personal income and inflation. Real disposable personal income rose at 3.0% year-on-year, about in line with the long-term average (3.2% since 1960), but above the nearer-term average (2.4% since 2013).
Source: Federal Reserve Bank of St Louis
A sharp decline in personal income growth towards zero usually indicates an imminent recession (note the gray bars in the graph below, which are recession periods in the U.S. economy):
Source: Federal Reserve Bank of St Louis
Although such a decline can occur rapidly before a recession’s onset, we note that current data do not suggest recession is imminent — in spite of fears sparked by an inversion of one interest-rate yield curve on March 15.
Don’t Fear the Inversion (Yet)
Although we’ve been discussing the yield curve for some time, the concept has now become ubiquitous in financial media (we noticed it become a hot topic sometime last year). As usual, the way it is discussed is often misinformed and alarmist, since media (not just financial media) have an interest in causing fear to grab eyeballs.
Remember that the yield curve is the difference, or “spread,” between two interest rates — one longer-term, and one shorter-term. Thus there are various “yield curves” that can be examined; the most common is the 2/10, that is, the difference between the two-year and 10-year U.S. Treasury bond interest rate. Others include the 6-month and 10-year, or the 3-year and 10-year. Some analysts (such as Canaccord Genuity’s Brian Reynolds, whom we respect) argue that it is more important to watch the spread between short- and long-term U.S. agency bonds (such as those issued by Ginnie Mae). We watch all of the spreads we have mentioned.
On March 15, the 3/10 curve inverted, prompting a flurry of news reports speculating breathlessly that in spite of the stock market’s strong performance year-to-date, the curve inversion signaled the imminent end of the post-2009 bull market. (The S&P 500 ignored the chatter and is up 2.5% since the inversion as of this writing.)
There are several observations to make.
First, yield curve inversion has the effect that it does, because it signifies an approaching crunch in the availability of credit. Therefore, it’s important to evaluate yield curve activity in the context of credit stress, or the lack thereof. There is no visible credit stress in any of the more-than-100 metrics tracked by the Chicago Fed:
Overall U.S. Credit Stress Is At Cycle Lows
Lower values indicate lower credit stress
Source: Bloomberg LLP
Other data show the same: surveys of senior loan officers, corporate bond spreads, household debt servicing ratios, consumer delinquencies, etc. The data simply do not show the kind of credit stress that says a recession is around the corner.
Second, yield curve inversion does not indicate that a bear market is upon us. On the contrary, the initial inversion of a significant yield curve typically indicates that a bull market is about to accelerate into its ultimate peak.
Last year, when we published our Recession Watcher’s Guide, we looked at past data, and saw that when the 6-month/10-year Treasury curve inverted, the market typically had more than 19 months to its peak, and gained almost 29% in that time:
Source: Guild Investment Management, Inc.
Since the inversion of the 3/10 Treasury curve was very brief, and since other financial news have been positive, the fear has dissipated. Bouts of it will certainly come again — perhaps when the 2-year and 10-year Treasury curve inverts. But when that fear arrives again, just remember: look at curve inversion in the context of other data, and expect that when the initial inversion has occurred, the market likely still has gains ahead before the peak.
Investment implications: The yield curve doesn’t function in a vacuum; it is connected to overall financial conditions, which remain very supportive. Also, the initial inversion of the curve typically indicates not the death of a bull market, but its acceleration into its final peak, often over a period of more than a year. Do not be dismayed by “yield curve” spin.
Microsoft Automates Data Storage On DNA
The digitization of everything means that around the world, embedded devices are generating unprecedented and almost unimaginable quantities of data. Those data are the basis for the blossoming field of artificial intelligence (AI) which finally has the real promise — long just a staple of science fiction — of allowing robots to take over many of the most grueling and tedious jobs that humans have hitherto had to do. We’ve often discussed the economic and social consequences of automation, but that’s not what we’re talking about today. Regardless of the disruption caused by AI and automation, which will be real, the economic benefits to consumers and companies will drive the process forward as far as the technology will allow.
Engineers have been aware for years that the generation of all the data that feed AI applications is going to become problematic as it outstrips the capacity of legacy memory systems. One proposed solution is the use of “molecular storage,” taking advantage of the structure of DNA to code data into molecules, which would increase the information density of our storage mechanisms by orders of magnitude.
Now Microsoft
How To Store Your Cat Videos In DNA Form
Source: Nature
Capacity isn’t the only advantage of DNA. While current data storage media, including magnetic drives, decay over a period of decades, data stored in DNA could last millennia (witness the successful extraction of DNA from the skeletal remains of woolly mammoths and Neanderthals).
Investment implications: We like to keep readers abreast of new technological developments. The development of DNA storage will not in itself be a needle-mover for MSFT. Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time. Currently, Guild’s clients own MSFT. In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.
Market Summary
The U.S., China, and Emerging Markets
Our investing attention remains focused on the United States, China, and some emerging markets (“China’s workshops”).
After the decline of the last quarter of 2018, U.S. stocks posted the best first-quarter performance since 1987, and global stocks the best since 2010 (in the flush of the global economy’s exit from recession, and the Chinese government’s enormous economic stimulus program).
While worry persisted about global growth during the first quarter, investors have begun to look ahead past a bottom of negative data and towards the reacceleration that we have been suggesting was in the cards since last year. Chinese data have begun to turn positive — such as the purchasing managers’ index (PMI) data released on Monday.
In the U.S., the Atlanta Fed GDPNow indicator has ticked up to 2.1% annualized; it was 0.17% in mid March. We performed an analysis of GDPNow’s track record back in 2016, and as you can see, it tends to vary widely from the real data as they are ultimately published. In short, you can’t rely on it to reflect current reality closely, but it certainly influences the opinion of the investing public!
Source: Guild Investment Management, Inc.
Chinese investors are borrowing to buy stocks; leverage there hit the highest level since 2015; at 11.5 times their anticipated earnings over the next twelve months, many regard Chinese stocks as still being cheap. (Though as we have noted many times, the key driver of the Chinese stock market is local investor sentiment.)
U.S. investors, for their part, have more cash to put to work in stocks; U.S. money market assets are near their highest levels in eight years.
In brief, we are bullish on the U.S. and emerging markets, and bullish on China. Within the U.S., we favor big cap tech, but prefer those that are not facing imminent scrutiny from regulators and public opinion.
Europe and the UK
We continue to watch the Brexit process (circus?) closely. We continue to believe that a successful Brexit — by which we mean simply a real one, deal or no deal, in which the UK succeeds in leaving without entanglements — will cause turmoil and will then ultimately be salutary for the UK economy, currency, and stock market.
Once Brexit is concluded, Europe may experience a relief rally; as we have often noted, while Europe has deep, unresolved problems, political and economic events can sometimes conspire to create a trading opportunity.
Thanks for listening; we welcome your calls and questions.
