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US Treasurys at ‘critical point’: Stocks, bonds correlation shifts as fixed-income market flashes recession warning

Bonds and stocks may be getting back to their usual relationship, a plus for investors with a traditional mix of assets in their portfolios amid fears that the US faces a recession this year.

“The bottom line is the correlation now has shifted back to a more traditional one, where stocks and bonds do not necessarily move together,” said Kathy Jones, chief fixed-income strategist at Charles Schwab, in a phone interview. “It is good for the 60-40 portfolio because the point of that is to have diversification.”

That classic portfolio, consisting of 60% stocks and 40% bonds, was hammered in 2022. It’s unusual for both stocks and bonds to tank so precipitously, but they did last year as the Federal Reserve rapidly raised interest rates in an effort to tame surging inflation in the US

While inflation remains high, it has shown signs of easing, raising investors’ hopes that the Fed could slow its aggressive pace of monetary tightening. And with the bulk of interest rate hikes potentially over, bonds seem to be returning to their role as safe havens for investors fearing gloom.

“Slower growth, less inflation, that’s good for bonds,” said Jones, pointing to economic data released in the past week that reflected those trends.

The Commerce Department said Jan. 18 that retail sales in the US slid a sharp 1.1% in December, while the Federal Reserve released data that same day showing US industrial production fell more than expected in December. Also on Jan. 18, the US Bureau of Labor Statistics said the producer-price index, a gauge of wholesale inflation, dropped last month.

Stock prices fell sharply that day amid fears of a slowing economy, but Treasury bonds rallied as investors sought safe-haven assets.

“That negative correlation between the returns from Treasuries and US equities stands in stark contrast to the strong positive correlation that prevailed over most of 2022,” said Oliver Allen, a senior markets economist at Capital Economics, in a Jan. 19 notes. The “shift in the US stock-bond correlation might be here to stay.”

A chart in his note illustrates that monthly returns from US stocks and 10-year Treasury bonds were often negatively correlated over the past two decades, with 2022’s strong positive correlation being relatively unusual over that time frame.


“The retreat in inflation has much further to run,” while the US economy may be “taking a turn for the worse,” Allen said. “That informs our view that Treasuries will eke out further gains over the coming months even as US equities struggle.”

The iShares 20+ Year Treasury Bond ETF TLT,
has climbed 6.7% this year through Friday, compared with a gain of 3.5% for the S&P 500 SPX,
according to FactSet data. The iShares 10-20 Year Treasury Bond ETF TLH,
rose 5.7% over the same period.

Charles Schwab has “a pretty positive view of the fixed-income markets now,” even after the bond market’s recent rally, according to Jones. “You can lock in an attractive yield for a number of years with very low risk,” she said. “That’s something that has been missing for a decade.”

Jones said she likes US Treasurys, investment-grade corporate bonds, and investment-grade municipal bonds for people in high tax brackets.

Read: Vanguard expects municipal bond ‘renaissance’ as investors should ‘salivate’ at higher yields

Keith Lerner, co-chief investment officer at Truist Advisory Services, is overweight fixed income relative to stocks as recession risks are elevated.

“Keep it simple, stick to high-quality” assets such as US government securities, he said in a phone interview. Investors start “gravitating” toward longer-term Treasurys when they have concerns about the health of the economy, he said.

The bond market has signaled concerns for months about a potential economic contraction, with the inversion of the US Treasury market’s yield curve. That’s when short-term rates are above longer-term yields, which historically has been viewed as a warning sign that the US may be heading for a recession.

But more recently, two-year Treasury yields TMUBMUSD02Y,
caught the attention of Charles Schwab’s Jones, as they moved below the Federal Reserve’s benchmark interest rate. Typically, “you only see the two-year yield go under the fed funds rate when you’re going into a recession,” she said.

The yield on the two-year Treasury note fell 5.7 basis points over the past week to 4.181% on Friday, in a third straight weekly decline, according to Dow Jones Market Data. That compares with an effective federal funds rate of 4.33%, in the Fed’s targeted range of 4.25% to 4.5%.

Two-year Treasury yields peaked more than two months ago, at around 4.7% in November, “and have been trending down since,” said Nicholas Colas, co-founder of DataTrek Research, in a note emailed Jan. 19. “This further confirms that markets strongly believe the Fed will be done raising rates very shortly.”

As for longer-term rates, the yield on the 10-year Treasury note TMUBMUSD10Y,
ended Friday at 3.483%, also falling for three straight weeks, according to Dow Jones Market data. Bond yields and prices move in opposite directions.

‘Bad sign for stocks’

Meanwhile, long-dated Treasuries maturing in more than 20 years have “just rallied by more than 2 standard deviations over the last 50 days,” Colas said in the DataTrek note. “The last time this happened was early 2020, going into the Pandemic Recession.”

Long-term Treasurys are at “a critical point right now, and markets know that,” he wrote. Their recent rally is bumping up against the statistical limit between general recession fears and pointed recession prediction.”

A further rally in the iShares 20+ Year Treasury Bond ETF would be “a bad sign for stocks,” according to DataTrek.

“An investor can rightly question the bond market’s recession-tilting call, but knowing it’s out there is better than being unaware of this important signal,” said Colas.

The US stock market ended sharply higher Friday, but the Dow Jones Industrial Average DJIA,
and S&P 500 each booked weekly losses to snap a two-week win streak. The technology-heavy Nasdaq Composite erased its weekly losses on Friday to finish with a third straight week of gains.

In the coming week, investors will weigh a wide range of fresh economic data, including manufacturing and services activity, jobless claims and consumer spending. They’ll also get a reading from the personal-consumption-expenditures-price index, the Fed’s preferred inflation gauge.

‘Backside of the storm’

The fixed-income market is in “the backside of the storm,” according to Vanguard Group’s first-quarter report on the asset class.

“The upper-right quadrant of a hurricane is called the ‘dirty side’ by meteorologists because it is the most dangerous. It can bring high winds, storm surges, and spin-off tornadoes that cause massive destruction as a hurricane makes landfall,” Vanguard said in the report.

“Similarly, last year’s fixed income market was hit by the brunt of a storm,” the firm said. “Low initial rates, surprisingly high inflation, and a rate-hike campaign by the Federal Reserve led to historic bond market losses.”

Now, rates might not move “much higher,” but concerns about the economy persist, according to Vanguard. “A recession looms, credit spreads remain uncomfortably narrow, inflation is still high, and several important countries face fiscal challenges,” the asset manager said.

Read: Fed’s Williams says ‘far too high’ inflation remains his No. 1 concern


Given expectations for the US economy to weaken this year, corporate bonds will probably underperform government fixed income, said Chris Alwine, Vanguard’s global head of credit, in a phone interview. And when it comes to corporate debt, “we are defensive in our positioning.”

That means Vanguard has lower exposure to corporate bonds than it would typically, while looking to “upgrade the credit quality of our portfolios” with more investment-grade than high-yield, or so-called junk, debt, he said. Plus, Vanguard is favoring non-cyclical sectors such as pharmaceuticals or healthcare, said Alwine.

There are risks to Vanguard’s outlook on rates.

“While this is not our base case, we could see a Fed, faced with continued wage inflation, forced to raise a fed funds rate closer to 6%,” Vanguard warned in its report. The climb in bond yields already seen in the market would “help temper the pain,” the firm said, but “the market has not yet begun to price such a possibility.”

Alwine said he expects the Fed will lift its benchmark rate to as high as 5% to 5.25%, then leave it at around that level for possibly two quarters before it begins easing its monetary policy.

“Last year, bonds were not a good diversifier of stocks because the Fed was raising rates aggressively to address the inflation concerns,” said Alwine. “We believe the most typical correlations are coming back.”



Opinion: This record number in Nvidia earnings is a scary sight

Nvidia Corp.’s financial results had a bit of a surprise for investors, and not on the good side — product inventories doubled to a record high as the chip company gears up for a questionable holiday season.

Nvidia reported fiscal third-quarter revenue that was slightly better than analysts’ reduced expectations Wednesday, but the numbers weren’t that great. Revenue fell 17% to $5.9 billion, while earnings were cut in half thanks to a $702 million inventory charge, largely relating to slower data-center demand in China.

Gaming revenue in the quarter fell 51% to $1.57 billion. Nvidia said it is working with its retail partners to help move the currently high-channel inventories.

While the company was writing off the inventory for China, its own new product inventory was growing. Nvidia NVDA,
reported that its overall product inventory nearly doubled to $4.45 billion in the fiscal third quarter, compared with $2.23 billion a year ago and $3.89 billion in the prior quarter. Executives cited its coming product launches, designed around its new Ada and Hopper architectures, when asked about the inventory gains.

In the semiconductor industry, high inventories can make investors nervous, especially after the industry had so many supply constraints in recent years that quickly swung to a glut of chips in 2022. With doubts about demand for gaming cards and consumers’ willingness to spend amid sky -high inflation this holiday season, having all that product on hand just amps up the nerves.

Full earnings coverage: Nvidia profit chopped in half, but tweaked servers to China offset earlier $400 million warning

Chief Financial Officer Colette Kress told MarketWatch in a telephone interview Wednesday that the company’s high level of inventories were commensurate with its high levels of revenue.

“I do believe….it is our highest level of inventory,” she said. “They go hand in hand.” Kress said she was confident in the success of Nvidia’s upcoming product launches.

Nvidia’s revenue reached a peak in the April 2022 quarter with $8.3 billion, and in the past two quarters revenue has slowed, with gaming demand sluggish amid a transition to a new cycle, and a decline in China data-center demand due to COVID-19 lockdowns and US government restrictions.

For its data-center customers, the new architectures promise major advances in computing power and artificial-intelligence features, with Nvidia planning to ship the equivalent of a supercomputer in a box with its new products over the next year. Those types of advanced products weigh on inventory totals even more, Kress said, because of the price of the total package.

“It’s about the complexity of the system we are building, that is what drives the inventory, the pieces of that together,” Kress said.

Bernstein Research analyst Stacy Rasgon believes that products based on Hopper will begin shipping over the next several quarters, “at materially higher price points.” He said in a recent note that he believes Nvidia’s numbers were likely hitting a bottom in this quarter.

“We remain positive on the Hopper ramp into next year, and believe numbers have at this point likely reached close to bottom, with new cycles brewing and an attractive secular story even without China potential,” Rasgon said in an earnings preview note Tuesday.

Read also: Warren Buffett’s chip-stock purchase is a classic example of why you want to be ‘greedy only when others are fearful’

Nvidia Chief Executive Jensen Huang reminded investors on a conference call that the company’s inventories are “never zero,” and said everyone is enthusiastic about the upcoming launches. But it doesn’t take too long of a memory to conjure up a time when Nvidia went into a holiday with an inventory backlog that included new architecture and greatly disappointed investors: Four years ago, Huang had to cut his forecast for holiday earnings twice amid a “crypto hangover” with similar dynamics to the current moment

Investors need faith that this holiday season will not be the same, even as demand for some videogame products declines after a pandemic boom just as the market for cryptocurrency — some of which has been mined with Nvidia products — hits a rough patch. Huang said that Nvidia’s RTX 4080 and 4090 graphics cards based on the Ada Lovelace architecture had an “exceptional launch,” and sold out.

Nvidia shares gained more than 2% in after-hours trading Wednesday, suggesting that some are betting that this time will be different. That enthusiasm needs to translate into revenue for Nvidia so that this big gain in inventories does not end up being part of another write-down at some point in the future.



FTX’s stunning collapse nothing like Theranos, says venture investor and crypto bull Tim Draper

Tim Draper, founder and managing partner of Draper Associates and Draper University, balked at comparing the stunning implosion of crypto trading platform FTX to the notorious biotech startup Theranos, in a conversation with MarketWatch.

“It’s not like Theranos,” he said. In a Friday phone interview, Draper said he hadn’t been aware of anyone genuinely comparing the downfall of the embattled FTX, which filed for bankruptcy protection on Friday, with Theranos.

FTX founder Sam Bankman-Fried, the now-former CEO of the platform and its associated companies, was facing an $8 billion shortfall, The Wall Street Journal reported.

However, some have been drawing such comparisons, including Galaxy Digital BRPHF,
CEO Mike Novogratz in an interview with CNBC: “You know, we basically have a situation that looks like Theranos,” he said on the business network on Thursday.

“I’m furious,” Novogratz said, referring to how FTX’s capsizing hurts confidence in the nascent crypto market, with bitcoin BTCUSD,
the progenitor of the current crypto, forming in the wake of the 2008-2009 financial crisis.

Theranos founder Elizabeth Holmes rose to prominence on the back of the belief that she had invented groundbreaking advancements in blood-testing technology. The company’s valuation grew to $9 billion as she attracted a wave of high-profile investors, including Draper, before it was uncovered that no such technology existed. She was convicted of fraud in January 2022.

For his part, Bankman-Fried, 30, announced his resignation from his position as the head of FTX on Friday. The SEC and DOJ are investigating FTX’s recent implosion, though at this point Bankman-Fried is not in any legal trouble.

The collapse comes as some had come to regard Bankman-Fried as a sort of savior to other beleaguered crypto firms earlier this year. SBF, as he’s sometimes known, was a member of MarketWatch’s list of the 50 most influential people.

Like Holmes, he was heralded as a phenom, appearing on the August/September cover of Fortune magazine as the “next Warren Buffett,” the legendary value investor.

The velocity of his downturn has also been stunning. His net worth had been estimated to be $15.6 billion before this week, according to the Bloomberg Billionaires Index. But now the vast majority of his fortunes has been wiped out, Bloomberg said.

According to WSJ, some $2 billion was poured into the three-year-old FTX with little oversight or sufficient scrutiny into its business.

The exchange lent billions of dollars to fund risky bets at its affiliated trading firm, Alameda Research, using money that customers had deposited at FTX, according to reports.

A spokesman for FTX declined to comment.

“This is about people who got ahead of their skis.” Draper said. He added, “I feel for those who got caught up in this mess.”

The venture capitalist and crypto enthusiast said he, for one, has never viewed SBF as the golden boy of crypto and has been broadly skeptical of platforms that don’t offer clear transparency regarding their holdings.

“I’ve been very cautious with DeFi [decentralized finance] and have avoided most of those,” said Draper, who is an investor in trading platforms Coinbase Global Inc. COIN,
and Ledger.

“You’re better with good solid management, good solid performance,” Draper said.

“I tend not to follow the hype,” he added.

For the most part, cryptocurrencies, including Ether ETHUSD,
and bitcoin, have been swooning as the FTX drama has unfolded. The stock market briefly jolted lower on Tuesday, with the Dow Jones Industrial Average DJIA,
shedding more than 600 points on Tuesday, before the broader market — including the S&P 500 SPX,
— bound back on Thursday, boasting a tremendous 1,200-point rally.

Further FTX reading:



Opinion: Tesla investors have been the biggest losers in Elon Musk’s Twitter deal, and those losses continue

Twitter users have complained a lot about Elon Musk’s early moves after taking control of the social network, but their complaints seem tiny compared with what Tesla Inc. investors have had to suffer.

As the US focused on election returns Tuesday evening, Tesla TSLA,
Chief Executive Musk tried to slip through disclosure of his long-awaited stock sales, revealing that he had sold nearly $4 billion of Tesla stock in the previous three trading sessions. Musk did not publicly address the stock sales nor his intentions to sell more within 24 hours of the disclosure, even while tweeting roughly 20 times in that period.

[MarketWatch asked him on Twitter to address the sales twice, and did not receive a reply; Tesla disbanded its media-relations department years ago.]

The sales fueled a further downturn in shares of the electric-vehicle maker on Wednesday, when the stock fell 7.2% to $177.59, its lowest closing price since November 2020. Tesla is currently down 49.6% on the year, which would be far and away the worst year yet for the stock — the previous record annual decline was 2016, when it fell 11%.

The problems for Tesla investors go far beyond Musk selling its stock so that he could overpay for a company with limited growth prospects and a host of other problems, but the poor optics certainly start there.

“He sold caviar to buy a $2 slice of pizza,” said Dan Ives, a Wedbush Securities analyst.

Ives was one of several on Wall Street to predict Musk would need to sell more shares to either close a gap in his financing of the $44 billion deal to buy the social-media company, or provide additional operating funds. In a telephone conversation Wednesday, he said the Twitter move is “a nightmare that just won’t end for Tesla investors.”

One reason it isn’t ending is that Musk’s need for cash in relation to Twitter is not done with the recent sales, portending more in the future. Musk said in a tweet late last week that Twitter had a “massive drop in revenue” due to activists pressing advertisers to pull their ads, and he will have to continue paying the employees he did not lay off while servicing a debt load that analysts have estimated will cost him $1 billion a year, much more than Twitter has cleared in profit in the past two years. Twitter reported a net loss of $221 million in 2021, and a net loss of $1.13 billion for 2020.

Read more about Elon Musk potentially pumping Tesla stock ahead of a sale

“The first two weeks of ownership have been a ‘Friday the 13th‘ horror show,” Ives said, adding that the verification plan and mass layoffs of 50% of employees — and then trying to rehire some of the engineers, developers and cybersecurity experts — was “really stupid.” And, according to CNBC, Musk has also pulled more than 50 Tesla engineers, many from the Autopilot team, to work at Twitter.

“But it’s consistent with how this thing has been handled,” Ives said, adding that Musk is “way over his skis” with the Twitter acquisition.

Amid all the chaos of his first two weeks running Twitter, how much time has Musk had to run his other companies? Musk was already splitting his Tesla time with SpaceX, The Boring Company, Neuralink and many other endeavors, and now he has taken on the gargantuan task of turning a social-media company that has never been highly profitable, nor valuable, into something worth the $44 billion he paid.

The effort, Ives said, has “tarnished his brand,” which in turn has a big risk of hurting Tesla. Many investors have bought into the Tesla story because they believe Musk is a genius and they back his vision of electrifying the automotive industry. Twitter does not meld into that vision, except as a platform to spout his opinions, vitriol and promote more wacky concepts.

Since Musk began his quest to buy the company, he has endured more criticism than ever before, with even some fans starting to throw shade or question his decisions. Investor Gary Black, managing partner of the Future Fund LLC, for example, pointed out that Tesla’s top engineers should not be running Twitter, where the news was getting worse.

Tesla is not a company that can just run itself at this point. Musk has claimed he did not want to be chief executive but that there was no one else to take over the car company, which is why he has served as CEO for years. It’s not clear, though, how much effort he actually has made at trying to recruit someone. Now, as Tesla faces its usual multitude of issues, he is off spending his time trying to turn Twitter into a payments company, or maybe a subscription company, or maybe an “everything app,” or whatever he comes up with tomorrow.

“Musk needs to look in the mirror and end this constant merry-go-round of Twitter overhang on the Tesla story, with his focus back on the golden child Tesla, which needs his time more than ever given the soft macro, production/delivery issues in China, and EV competition increasing from all corners of the globe,” Ives wrote in a note Wednesday, in which he reiterated an outperform rating on Tesla stock.

For Twitter to reach anywhere close to the valuation Musk paid for it, it’s going to need a ton of attention from a focused leader, but how can Musk be that leader and give Tesla the attention it deserves? The answer is he cannot, and is very likely to give the attention that Tesla needs to Twitter instead after committing $44 billion (not all of it his) to that endeavor. Tesla investors will be left staring at the sea of ​​red that this year has wrought, and wondering if its leader is about to sell more shares to fund his other effort.