Markets dive on recession fears

Wall Street has fallen sharply after the bond market flashed a recession warning for first time since 2007.

Trader John Romolo watches stocks dive on the New York Stock Exchange. Picture: AP

US stocks slumped and Treasury markets have sent a new recession signal after weak German and Chinese economic data stoked fears of an impending global slowdown.

The Dow Jones Industrial Average dropped 800 points, or 3 per cent--its biggest loss of the year--while the yield on the US 30-year Treasury bond fell to a record low.

Australian stocks are tipped to follow suit, with the SPI futures index predicting a fall of 128 points at the open.

The drops erased the optimism sparked a day earlier when the Trump administration abruptly suspended plans to impose new tariffs on goods from China and suggest the volatile swings that have defined trading in August are showing no signs of easing.

Trade tensions between the US and China, uncertainty about the Federal Reserve’s interest-rate policy and signs of slowing economic growth have spurred weeks of turbulence that have rippled through the stock, bond and currency markets since major stock indexes hit all-time highs in mid-July.

In the Treasury market, the yield on the US 30-year Treasury bond touched 2.018 per cent, according to Tradeweb, below the previous intraday low of 2.094 per cent in July 2016. The 30-year is the longest type of US government debt and one of the most sensitive to changes in expectations for long-term growth and inflation.

Meanwhile, yields on the 10-year Treasury note briefly fell below two-year yields for the first time since 2007. This kind of inversion between short and long-term yields is viewed by many as a signal that a recession is likely in the future.

“Whether we go into recession now or we don’t, it’s not a good sign,” said Michael Farr, president of investment firm Farr, Miller & Washington. “You’re going to see investors temper their enthusiasm more seriously today.”

The yield-curve inversion spooked investors, but some money managers cautioned that a recession or prolonged stockmarket downturn isn’t necessarily imminent. With bond yields at multi-year lows, many investors say there are no good alternatives to US stocks for those seeking returns. The S&P 500 sports a dividend yield of roughly 2 per cent, well above the nearly 1.6 per cent yield on the 10-year Treasury note.

Markets also tend to keep moving higher immediately following a yield-curve inversion. Since 1978, the S&P 500 has risen 13 per cent, on average, from the first time the spread inverts on a closing basis to the beginning of a recession, according to Dow Jones Market Data.

Mr Farr said in this tumultuous environment, investors need to make sure that the companies they own have strong balance sheets cash flow, without much debt. He added he likes companies that tend to do well even if the economy sputters, like Procter & Gamble, PepsiCo and Johnson & Johnson.

This latest inversion, though, is particularly concerning to some investors given it comes on the heels of the Fed cutting short-term rates last month. Many traders and analysts are now looking for additional intervention by the Fed to extend the economic expansion in the U.S.

President Trump called out the Fed in a tweet, saying the central bank raised interest rates too quickly and is now too slow to cut.

“CRAZY INVERTED YIELD CURVE! We should easily be reaping big Rewards & Gains, but the Fed is holding us back. We will Win!” he said.

..Spread is way too much as other countries say THANK YOU to clueless Jay Powell and the Federal Reserve. Germany, and many others, are playing the game! CRAZY INVERTED YIELD CURVE! We should easily be reaping big Rewards & Gains, but the Fed is holding us back. We will Win!

— Donald J. Trump (@realDonaldTrump) August 14, 2019

Expectations for further rate cuts jumped Wednesday, with Fed-funds futures showing a market-implied probability of nearly 20 per cent that the central bank cuts rates by 50 basis points in September, up from 4 per cent a day ago.

“The Fed doesn’t have the cure for an economic slowdown or recession,” said Kristina Hooper, chief global market strategist at Invesco. “But I do think the Fed has the antidote for the stockmarket sell-off.”

Though US Treasury yields have fallen precipitously, they remain higher than the debt on most developed countries around the world. Yields are negative in Japan and much of Europe, sending investors piling into U.S. bonds and pushing prices higher and yields lower.

“Investors globally have no where else to go for yield,” said John Brady, managing director at brokerage R.J. O’Brien & Associates.

The S&P 500 and Nasdaq Composite declined 2.9 per cent and 3 per cent, respectively, after the indexes rose by more than 1 per cent Tuesday. The S&P 500 notched its sixth swing of at least 2 per cent this year and its sixth consecutive move of at least 1 per cent. The benchmark index has dropped 6.1 per cent from its closing record last month.

All 11 sectors in the index declined in Wednesday’s sessions, led by energy stocks, which slumped as the price of US-traded crude oil dropped 3.3 per cent. Bank stocks also underperformed as lower yields can weigh on their lending profitability. Citigroup fell more than 5 per cent, while Bank of America dropped 4.7 per cent.

After rallying Tuesday on the tariff reprieve, shares of retailers tumbled as Macy’s lowered its earnings outlook, a troubling sign heading into the key back-to-school and holiday seasons. The department-store operator’s shares fell 13 per cent, dragging down shares of Kohl’s and Nordstrom as well.

Market swings tend to be exaggerated when trading is slow. Stock- and bond- trading volumes have been lower than normal this August, JPMorgan Chase analysts said in a recent note.

“Volumes are actually not that prevalent at the moment because yesterday the market did the opposite, so people are at a standstill position,” said Mohit Bajaj, director of ETF trading solutions at broker WallachBeth Capital LLC. “We’ll see what happens in September when people are back from vacation.”

It isn’t unusual to see swift drops this time of year. In August 2011, the stock market tumbled after the Standard & Poor’s downgraded US Treasury debt, and in August 2015, US stocks tumbled in tumultuous trading after Beijing’s unexpected move to devalue its currency.

Elsewhere, European stocks fell after data showed the German economy shrank in the second quarter. The Stoxx Europe 600 dropped 1.7 per cent, while the German DAX fell 2.2 per cent.

Germany’s economy contracted by 0.1 per cent in the second quarter due to further declines in exports, and the latest data mean that average quarterly growth has been zero since the third quarter of 2018, according to ING.

The data put pressure on the German government to stimulate the economy through tax cuts or public spending, and the yield on the 10-year German bund touched a fresh record low of minus 0.645 per cent, according to Tradeweb.

The debilitating effect of trade tensions also was visible in Chinese data, as value-added industrial production in the country grew 4.8 per cent in July, significantly lower than the 6.3 per cent increase in June and below expectations of 5.9 per cent growth.

Still, Asian stocks rallied on the tariff delay, with shares in Shanghai up 0.4 per cent and Japan’s Nikkei up 1 per cent. Hong Kong’s Hang Seng added nearly 0.1 per cent as the city continued to struggle with protests and violence.

Dow Jones Newswires