Last Week’s Price Action
The previous week saw a sharp global equity rally to include U.S. equities along with further sharp recovery in high yield or junk bond prices. The market appears to have shrugged off most concerns including interest rate concerns.
Beware Inverted Yield Curve
Given last week’s price action it it worth considering the idea that market participants are myopic or put too much weight on short term interest rates, especially the target federal funds rate “suggested” by the Federal Reserve. The target federal funds rate, by itself, is of little importance. Of great importance, however, is the slope of the yield curve. All else equal, a positively sloped yield curve translates into increased lending activity by banks. Borrow short, lend long, capture the spread. This is what banks, the ones that actually perform banking functions, do to make money. If the slope of the yield curve inverts, this throws a wrench into the works and lending slows. While the markets have been making new highs, the yield curve has been slowly flattening. At present the danger is likely minimal as a rally can continue for some time after the curve inverts. As this bull market progresses, beware an inverted yield curve.
LEI
The Conference Board’s Leading Economic Index for the U.S. in October was nicely positive and therefore resets the two key “gauges” in the economic indicators section of the market notebook. The LEI is one of the most important indicators followed by the notebook and such a nicely positive reading is suggestive of continued growth in the real economy.
XLY
A sector chart that caught my eye this week is the chart of XLY, Consumer Discretionary. The parabolic nature of recent price action looks too good to be true thus XLY looks ripe for a pullback here. It will be interesting to see how the chart develops during the next week.
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