Dave Rosenberg is one of North America’s better known economists. He works for the Canadian wealth management firm. Gluskin Sheff and Associates and writes an entertaining daily email.
Yesterday we got two (Thursday being Canada Day and a holiday).
In it he looked at the end of the quarter and where the US economy might be headed.
We have said time and again that the most important driver of bond yields is the direction of inflation.
This is twice as important as fiscal policy, as an aside. U.S. core inflation (which excludes food and energy) is already near-record low rates — at 0.9% year-over-year, it is just 20bps from the all-time low of 0.7% seen in March 1961.
Could the core inflation rate head lower?
We took a closer look at what’s behind the 0.9% core rate.
Core goods (commodities excluding food and energy) is running at 1.1% while core services (services less energy) is running at 0.9%.
It struck us that there is a very real chance that the core goods component could indeed be headed lower given that commodity prices have rolled over, and as we see the lagged impact of the strength in the U.S. dollar dampen import costs.
Core inflation is basically at zero, and very possibly turns negative.
Over the past decade, we have seen the long bond yield average 240 basis points above the core (and headline) inflation rate.
This means a long bond yield of 2.3%, and a 10-year note yield of 1.9%.
This is the future. Just think of what these rates will end up doing to the housing market.
At the margin, it will help absorb the de facto 26 months of excess inventory and finally put a floor under residential real estate prices.
As for the equity market, the news, unfortunately, is not good.
The S&P 500 has broken below the key line of support for the past five months of 1,040, and since technicals do account for something, especially in a market where the technicals have been dominant for over a year, a move to 880 on an interim basis seems likely.
We cannot be emphatic enough about what happened today (Wednmesday) over and beyond the close below 1,040 on the S&P 500.
The market closed near its low for the day and at the low for both the month (-5.4%) and the quarter (-12%).
At the same time, Treasury yields out the curve also closed at their lows for the month and the quarter.
The prospect of a major capitulation in the third quarter, which would reinforce the second quarter trend in bond yields and equity valuation, would seem to be rather high at this point.
Strong balance sheets, positive net free cash flow yield, earnings stability, non-cyclical sectors and dividend growth and yield are all the characteristics that should be screened for in any equity market investments.
