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Always something happening and nothing going on

The Days Ahead: The European long holiday keep things quiet. Jobs number on Friday.

One Minute Summary: We had three out of four trading days where the market moved by more than 1.3%. But there was no change over the week. Bonds had a good week. European markets were up but Asian stocks are still trying to figure out what the trade talks do for them. Companies like Toshiba, Sharpe and Nintendo were down 6% to 8%. The Euro and the Yen took a break from their steady rise this year but that was probably due to some cross-currency funding needs of major banks (the rule on overnight funding changed with tax reform).

Stock volatility feels high. But it's no different from its long-term average. Stocks have gradually got cheaper these last few weeks. We've seen no downward revision of earnings. While the economy is not quite the tear the tax cut crowd thinks, we’re a long way from recessions and economic downturns. Sentiment is shaken but if that flushes out some of the fast money especially at a quarter end, then… good.

1.     Tech Wash Out. When companies grow big and dominant they attract attention. In Europe, it tends to come with taxation. In the U.S., it's regulation. The driving themes of tech in the last few years were a mix of i) almost measureless scalability ii) the network effect (i.e. the more people use something, the more valuable it becomes to the community) iii) growth and iv) real oligopoly. These are exactly the same arguments in the last tech boom, the IBM and BUNCH stocks in the 1970s and all the way back to the Bell System in the 1900s.

It was perhaps inevitable that one or more of the current tech leaders would trip. It happened to be Facebook. It wasn't the first to break the rule of corporate communication (don't let the lawyers run your PR) but it did an outstanding job of going to ground and coming up with a sort-of-sorry mistakes-were-made-apology. But when investors are looking to sell stocks that had massively outperformed the market over the last three years, then any news becomes a reason to sell. Europe thinking about imposing a sales tax on tech companies. Sell. Tesla’s debt downgraded. Sell. Nvidia, a stock that has risen 700% in two years, said it won't be testing autonomous vehicles for a while. Sell. Twitter and privacy. Sell.

Tech has had phenomenal run. And it’s not nearly as overbought as in the 1990s. Here’s a chart showing the performance of tech against utilities, the ultimate defensive sector, in the 1990s and in the last 10 years.

It certainly looks like a bubble but on a much smaller scale. What concerns us is that many investors have left conservative investments and put an awful lot of faith in a few growth stories. For the last five years, tech has beaten utilities hands down, up 150% against utilities up 54%. But since the 2000 tech peak, it’s a very different story. Tech has risen 78% and utilities by 224%. It took 14 years to get back to break-even if you’d bought tech in 2000. For utilities it was just over four years.

So? Well we’d just reiterate the theme that diversification is very important. And we’d expect this period of volatility to continue.

And from the history rhymes library, here’s a pretty fierce response from the head of AT&T when the government started the breakup of the Bell companies in 1981.

2.     What’s the bond market saying? That growth isn’t going to last. And that inflation won't be a problem. We feel pretty confident about the second. Primarily because we think there’s more slack in the labor market than many realize. We wrote about it here. On the first, though, you've probably heard about the yield curve flattening. This is when short-term rates increase but long term rates stay sticky. There are lots of ways to measure it but here's the spread between 3-month Treasury bills and 10-Year Treasury notes.

Even at the height of QE when the Fed bought every Treasury and MBS in sight and so pushed yields down, the spread was 2.25%. After the election, in the heady days of growth, deregulation and tax cuts, it steepened sharply. But it's been falling ever since and especially so this year. It's now down to 1.02%.

To us, the market is saying that i) tough trade talk may sound good but there is probably nothing economically constructive that can come out of them ii) the twin deficits are going to need financing and the financing is going to come at the short end of the market and iii) the markets are nervous about growth. So, why not hold longer term Treasuries because they're not going to change…only the short end will.

That's our view certainly. We really don't believe in the “bear market for bonds” hype. We think rates are pretty well underpinned at the 2.7% to 3.0% range and will stay there for much of the year.

Bottom Line: Another short week. Asian markets grappling with the trade tariffs. As clients know, we’ve placed some protection on U.S. stocks. Expect volatility to remain high.

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