Stock Markets Plunge 3% Wednesday on Recession Worries

Stock Markets Down

This week’s trading has been a real ping-pong match so far. On Wednesday, the bears served up another big losing day, with yield inversion fears back in full force.

The usual suspects on the bear side were in full force on Wednesday, causing a loss of 800 points on the Dow in the biggest one-day loss since last December 4. The fears out there basically boil down to ones involving the risk of a recession coming, led by the claim that the bond market is predicting or indicating a recession from its bullishness.

We had these worries peak like this earlier in the year, and this did send us down for a time until cooler heads prevailed, or at least it seemed. Lower bond yields and lower stock prices do seem to go together during these times, but that’s only because traders are selling off at these times, including Wednesday and these traders can and do turn on a dime.

Understanding is power though when it comes to managing your stock positions, and as it turns out, it’s actually ironic that lower yields in themselves would produce either lower stock prices or even a dimmer view of the economy, and this is where the real inversion is taking place, where we are inverting reality.

Perhaps the most important point to understand, when this happens, is what moves both stock and bond markets day to day. A lot of people think that moves like we are seeing in both markets, the bulls running bonds up so much and stock prices going down as a result represents more than a small percentage of stakeholders in either market.

When we don’t understand this properly, this leads to views such as the stock market is selling off, or worse, that bond investors are being satisfied and even welcoming smaller yields. Neither of this is true and especially not the observation about the bond market.

Both markets have a certain float and it is variable, and the float here is the assets that are involved in trading on any given trading day. In periods of higher volatility, such as we’re seeing now, the float does expand, but it still does not expand that much and is still only representative of a small portion of the overall assets that are traded in these markets.

Over time, in bear markets, this float does expand to include more participants, when more and more stakeholders look to bail. On any given day there is a certain float that is ready to jump on and off at any time, and we can call this tendency the sensitivity levels of the participants.

The bigger the news, the more this float expands, and there will be some traders who might close their positions on a 20 point move down, even more who will do so with a 200-point move, and more again who would sell if we hit 400 points.

Real investors aren’t going to care about anything this small, and this is the case with both stocks and bonds, although if we keep moving down, more and more will jump on the bandwagon. Even during a crash though, most of the people will just be holding on, and if they weren’t, we’d crash a lot more.

We might therefore think that investors are worried about a recession right now but the truth is that some traders are, but most of the shares in the market, the great percentage of them, aren’t involved in these things. Even investors who are looking to cash in aren’t the sort to time their exits like this even when it may be to their advantage to do so, although the ups and downs of this week wouldn’t even qualify for this.

Investors Are in For the Longer-Term and Need not Be Concerned with Noise Like This

We need to focus on what matters to us and what is relevant to our goals, and if we’re investors we therefore need to concentrate on what would matter to investors. If we are traders, we do care about moves like this and actually would want to not only pay attention but benefit from these moves.

The bullish market with bonds is like that as well, but this time, most bondholders couldn’t give a hoot at all about what the yields are on bonds that people are buying today, because they already have locked in their yields and this only matters if you’re looking to sell your bonds.

Bull markets do indicate more demand for something, demand outpacing supply that is, and we do have that right now with bonds to be sure. Since we’re dealing with the impact of the bond trading that is going on, we can’t say that current yields indicate that people think that a recession may be coming or anything of the sort, and the fact that the prices of bonds just keep rising is plenty reason for them to buy more.

There are also currency considerations, and a lot of people who want to own the dollar will buy treasuries, especially if treasuries are doing so well as they are now. You get to ride the dollar and also ride the treasuries, and this isn’t typically a long-term strategy at all, and not even one that is concerned about yields at all, it’s about other forms of speculation.

If we’re going to make the leap to assume that the bond market somehow leads the economy, we need to establish good reasons for this or even how this could ever be true. The bond market isn’t even predicting much here other than bonds being a good investment, and given that they rise in value as yields decline, declining yields make them an even better one.

Eventually, the piper will have to be paid for all of this zealousness, at a point where yields start going up too much. This is an actual fear. For now, we are still eating, drinking, and being merry, and historically merry at that.

Sometimes we get anomalies such as shorter-term treasuries yielding less than longer-term ones, and we might think that this may predict some sort of undesirable economic fate, but you would only think that if you were confused about what these traders are trying to do. If the two year is hotter than the 10 year, that may just mean that people are more optimistic about the 2 year than the 10, and the optimism here means that they expect prices to appreciate more.

Bond traders certainly don’t have any special knowledge of economic forecasts, something that central banks such as the Fed aren’t aware of, so if the Fed tells us that things are fine and the bond market seems to suggest that things aren’t so great, it would not make sense to believe the bond market even if this were the message. It isn’t, and the message really is that bonds are hot right now.

The great majority of the money in the bond market isn’t interchangeable with stocks, so it’s not that they are choosing bonds over stocks in any meaningful way right now, although it is true that during bad times in the stock markets, investors will sell their stocks and buy bonds. Most of the money in the bond market is put there because people just want bonds or they may actually want the dollar and this has them gravitating toward U.S. treasuries more.

Unless you are holding these bonds to maturity, you don’t really care that much what the yield is, and all that negative yield debt out there speaks very loudly to this. When yields are negative and you are in it for the yield, this isn’t even sane, and when we see the demand for these negative yielding bonds go up and the yields drop further, that should tell you what really drives this demand, and you can bet your life on this not being to earn yields.

Ironically, Dropping Yields Are Actually Bullish for the Economy and for Stocks

What is really ironic about the view that bonds lead the economy and dropping yields portend bad times is that dropping yields are great for the economy and cause an expansionary effect, similar to what interest rate cuts by the Fed do.

There are people who are clamoring for the Fed to reduce interest rates more in order to somehow combat falling bond yields, but if anything, this would make the Fed more reluctant to want or need to cut rates because the bond market helps this cause, not hurts it.

Rising demand for bonds expands the debt market, where there are more people willing to lend and at lower rates, which strengthens the economy. There’s also the matter of both the government and companies being able to borrow more and more cheaply because of this, another positive if you wish to see the economy grow more.

Bonds also affect credit markets in an expansionary manner, as this puts interest rates down for credit, especially with mortgages. More people buy homes and that’s another way that the economy grows from this.

People who own stocks should actually be cheering for yields to drop even more, and if they own bonds as well, this also puts the value of their bonds up, both in terms of their market value and the value of the interest stream they bought with them.

This is why the real inversion here involves not inverted bond yields but inverted reality. As always, inverted reality gets to play their tune in the stock market, although those with longer term views or even anything but a short-term view can just ignore this tune.

People aren’t parting with very many of their shares, even with an 800 point down day though, but traders have, and these traders follow the momentum. Thursday may bring us another rebound and they will either be riding that up or riding the further move down if we’re unable to build enough positive momentum yet.

This is nothing that investors need concern themselves with though, either the pullbacks in the stock market or the declining yields with treasuries, and it’s not even a concern anyone but short-term traders really need to pay attention to. One day or even a few minutes may be the whole ball game to them, so it stands to reason that they will pay a lot of attention to these things.

There doesn’t seem to be much actual reason for the Fed to cut rates again this year, even though a lot of people just can’t help getting ahead of things and we therefore see things like markets pricing in rate cuts already. Rate cuts help bonds as well though and put yields down even more, so bond traders are rooting for more right alongside people in the stock market.

We’ll have to see what happens, although if we do get more of this, it will be in spite of low yields, not because of them.



Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.