Morning Comment: Yield Curve Showing Signs It Could Steepen

  • The stock market’s nice rally from early June has actually flattened out quite a bit recently.
  • At some point, renewed “trade talks” are going to be viewed as the boy who cried wolf.
  • Semis breaking slightly above old highs…Any further upside follow-through will be quite bullish.
  • The early reaction to the DOJ’s new “antitrust review”: Surprising complacency.
  • The yield curve is showing signs of reversing.
  • If it steepens, it’s obviously going to have a BIG impact on groups like the banks & utilities.

Nice rally, but has been flattening out recently

News flash…earnings are coming-in better than expected!!! Of course, they have been better-than-expected every quarter since God was a child…because the estimates are always lowered enough so that they can be exceeded…but it does give something for people to talk about whenever the market rallies on a given day during earnings. Don’t get us wrong, the percentage of companies beating estimates is higher than usual. It’s about 80% so far vs. the usual number in the low 70s…but we’d also highlight that the stock market really hasn’t done anything over the past three weeks. So the reaction to the earnings season really hasn’t been anything special so far.

Actually, even though the estimates are always lowered enough that they can be exceeded, sometimes stocks SHOULD rally on better-than-expected earnings. However, that’s only when the stock market goes down at the same time the earnings estimates decline before earnings season. When the stock market RALLIES strongly in the 6-7 weeks leading up to earning season (like it did this time around)…while those estimates are coming down…it makes it difficult for stocks to sustain much of an “earnings rally.”

Earnings did not get all of the credit yesterday, however, as the market shot-up after a headline hit the tape…saying that U.S. negotiators are heading to China to face-to-face trade talks. That’s great, but somebody needs to re-program the aglos. At some point, we’re going to have to get some concrete news that some real progress is being made….a it is getting to the point where we have to consider these kinds of headlines like the boy who cried wolf.

The chip stocks act well....

Anyway, we don’t mean to sound so cynical. The stock market has had a great year so far this year…and we’re about to get some more easing from several global central banks. Therefore, the 2019 rally could certainly continue…and given that TXN reported good earnings last night, maybe this earnings season can indeed help fuel a further rally. Those TXN numbers has the stock trading well above its old highs…and has the SMH semiconductor ETF trading slightly above its old highs in the pre-market. As we said yesterday, a meaningful move above that old high will be quite bullish for the broad market…because the semis have been a very important leadership group over the years.

.....but will the DOJ stymie the rally in the tech stocks?

The news that the DOJ has opened a broad antitrust review of the big tech companies has the FAANG stocks trading lower. This does not seem like it will have a direct impact on the semis, but if it hurts the tech group over time, it could cause some “indirect” problems for the group..…..To be honest, the FAANG stocks are not down very much at all in pre-market trading. We’re a little surprised by this…because this investigation is going to hang at least a small cloud over these names for a long time. More importantly, the justice department rarely spends a lot of time and money on an investigation…and them come back with only a few minor recommendations. This is especially true when it deals with an issue that both sides of the political aisle agree on! Therefore, there’s no guarantee that the reaction to this new-news will continue to be benign over time.

The S&P is still at a key technical juncture

Again, even though the stock market has rallied nicely this year…and has also seen a strong bounce since the early June lows…it hasn’t done anything over the past three weeks. This does NOT mean that the stock market has to roll-over from here. The recent hiatus might just be a normal/healthy “breather”…that takes place before we see another leg higher. However we do think the recent “flattening out” of the rally reinforces our contention that the stock market is still at a critical juncture on a technical basis. Therefore, we’ll definitely need more upside follow-through before we can say that a true breakout from the old highs has taken place. This is especially true given that the S&P has failed to breakout each of the past three times it has made a new record over the past 19 months.

The yield curve is showing signs of reversing

Away from the stock market, we were surprised that one development did not get more attention yesterday. The yield curve moved out of inverted territory yesterday…as the 3mo/10yr spread closed at a positive level yesterday. It was only a very mild pop above zero…and it has fallen back slightly into negative territory this morning, so we CERTAINLY CANNOT SAY that the inversion has run its course. However, there is no question that both the 3mos/10yr spread…and the 2yr/10yr spread…ARE showing SOME signs on the charts that the worst of their flattening/inverting moves are behind them!

Let’s look at the 3mos/10yr spread first. It has broken above its trend line from late 2016 and looks like it may have made a nice “double-bottom”……As for the 2yr-10yr spread, it has also moved above its 30-month trend-line…and the sideways range that it has been-in for many months shows that it is trying to form a nice “base”.

As you can see from the middle of the three charts we attached above, we’re going to have to see a more material steepening move before it can confirm a change in trend…but this is something that investors will ABSOLUTELY NEED to keep a VERY close eye on over the coming days and weeks. If (repeat, if) the curve starts to steepen in a more significant fashion, it’s going to be INCREDIBLY important for several equity groups. For instance, the XLU utility ETF is still very close to its all-time highs, BUT the decline it has seen over the past three days has taken it down to its 50 DMA…which has bee excellent support for the XLU since February. So if the yield curve steepens more, this group will become quite vulnerable.

A steeper yield curve will have a big impact on several stock groups

Any further steepening of the curve should also have powerful impact on the bank stocks. We’ve heard pundits speak very bullishly about the banks for 2.5 years…only to have the group BADLY under-perform the broad stock market. During all of those 2.5 years, the yield curve moved steadily lower (flatter), so if it can finally steepen in a compelling way…over a measurable period of time…it should FINALLY be very bullish for the bank sector.

Going from a red flag to a yellow one on the bank stocks

We have been bearish on the bank stocks throughout this entire period of its underperformance. HOWEVER, we are now changing the red flag to a yellow one on the bank stocks…and we’ll have the green flag right at the bottom of the flag pole…ready to go. If the yield curve steepens further over the coming weeks and months, the banks are going to fly!!!

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Matthew J. Maley

Managing Director

Chief Market Strategist

Miller Tabak + Co., LLC


275 Grove St. Suite 2-400

Newton, MA 02466


Although the information contained in this report (not including disclosures contained herein) has been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. This report is for informational purposes only and under no circumstances is it to be construed as an offer to sell, or a solicitation to buy, any security. Any recommendation contained in this report may not be appropriate for all investors. Trading options is not suitable for all investors and may involve risk of loss. Additional information is available upon request or by contacting us at Miller Tabak + Co., LLC, 200 Park Ave. Suite 1700, New York, NY 10166.

Posted to The Maley Report on Jul 24, 2019 — 9:07 AM
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