20 Oct YESTERDAY’S TREASURY TRADING WAS THE INVERSE OF THE PRIOR DAY
Can it be suggested the Treasury market is being ruled by algorithmic trading or trading based upon three- or four-word headlines? It widely documented that over 95% of Treasury trades are done electronically and because of its perceived liquidity algorithms exert great influence.
Monday the yield curve flattened as the inflation data was stronger than expected. The two-year Treasury dropped in price on the belief that the Fed will alter monetary policy 6-18 months earlier than anticipated [Note: The 2-year Treasury is the instrument most sensitive to monetary policy]
Longer dated Treasuries—defined as maturities greater than 10 years—did drop in price but not as much as the 2-year Treasury. The curve between the 2 year and 30-year Treasury flattened about 5 basis points.
Fixed income trading 101 would have suggested that longer dated Treasuries would have sold off more than the two-year Treasury, the yield curve would steepen, but it did not under the simple guise “the market” believes the Fed will be ahead of the proverbial inflationary curve.
Yesterday the inverse occurred. The data was weaker than anticipated, the two-year Treasury rallied and the longer dated Treasuries sold off and the Treasury curve steepened by almost 9 basis points under the simple premise the Fed will not have to act preemptively, thus suggesting that it may fall behind the proverbial curve.
Fixed income 101 would have suggested the inverse would have occurred.
Yesterday I wrote Will next week be the inverse…longer dated Treasuries sell off on the view inflation is not transitory but shorter duration rally on conviction of Fed policy?
Little did I know that it would occur the next day.
In the introductory paragraph I commented that the Treasury market is the most liquid in the world. According to Goldman Sachs, liquidity is challenged at best based upon how much the market moves given an amount of buy or sell orders.
Was this lack of liquidity front and center yesterday and Monday? I think yes.
Many times, I have commented about the five-name domination of the S & P 500. Goldman wrote yesterday that FB, AAPL, AMZN, MSFT and GOOG comprises 23% of the benchmark. The only time it was higher than this was the 27% level achieved last year.
Morgan Stanley writes 88% of the S & P 500 members have declined at least 10% this year. The S & P maximum decline was 5.2%, the result of these behemoths.
Morgan Stanley further states in all the prior occasions when at least 85% of the index’s constituents posted a loss of this magnitude, the S & P 500 posted a correction of 10% or more. The Bank writes “this is an extreme anomaly and the key takeaway the index continues to be the last holdout of this rolling correction,” suggesting if these companies underperform so does the indices.
Raymond James states 40% of the S & P 500 is comprised of technology. I do not know what companies they classify as technology, but this is consistent with other firms’ research suggesting technology is anywhere from 40% to 65% of the S & P 500 capitalization.
This massive concentration of wealth in one sector is also unprecedented far eclipsing any other record by a large amount. Is this sustainable?
Perhaps the only appropriate comment is that it will take a lot of fire power to maintain such concentration at the expense of all other sectors.
The three best performing S & P 500 sectors for 2021 are energy (57%), financials (36%) and real estate (29%). The weightings of these sectors in the S & P 500 are around historical lows by a factor between 3 and 5.
In other words, no one owns these sectors and any buying will boost shares.
Will this continue? A basic premise for a sector/company trade higher is more buyers than sellers. If everyone owns it, who is left buy when selling commences?
There has always been the debate that if the S & P 500 declines everything in the index will also decline. I do not argue with this premise but I will argue—a view espoused by Morgan Stanley—if the largest companies struggle so will the indices by an amount greater than historical percentages, the same trade of the past several years but in the different direction.
Last night the foreign markets were mixed. London was up 0.08%, Paris down 0.08% and Frankfurt up 0.14%. China was down 0.17%, Japan up 0.14% and Hang Seng up 1.35%.
The Dow should open flat. The 10-year is up 1/32 to yield 1.64%.