Cliff Hangers

With earnings season in full swing, I was unable to write a post last week. While it remains very early, so far Q2 2018 looks similar to Q1 2018, but with a more favorable weather comparison and tariff concerns sprinkled on top. I plan to get through the remaining quarterly reports and calls over the next two weeks.

Once the excitement of earnings season comes to an end, it will be interesting to see where the market turns its attention. Although I don’t have a strong opinion on Wall Street’s next narrative, the recent rise in interest rates would be on top of my list. In fact, I can’t keep my eyes off the 2-year Treasury yield as it continues to rise like a FANG stock (or at least before last week)!

To illustrate, below are two charts (both two years). One is a chart of the 2-Year U.S. Treasury yield and the other is a chart of QQQ. Which one is a portfolio of popular growth stocks and which one is the yield of a boring short-term USTN? They’re very similar, aren’t they?

  

If you guessed chart 1 was QQQ and chart 2 was the 2-year USTN yield, you are correct. Now which one is more exciting and enticing? I’d go with chart #2, or the 2-year Treasury yield!

  

Given where we are in the profit, credit, and economic cycle, I continue to believe the 2-year Treasury yield and equity markets will remain correlated. However, I also believe there is an eventual breaking point in these charts – they cannot rise together indefinitely. At what rate will the 2-year yield reach before asset prices crack? I wish I knew, but I find the equity market’s lack of concern fascinating. It reminds me of the game Cliff Hangers on the Price is Right. The mountain climber marches higher and higher until the contestant makes a large valuation mistake, resulting in the climber falling off the cliff (Cliff Hangers video).

I plan to continue watching the sharp rise in short-term yields with amazement and an opportunistic mindset. Although the timing remains uncertain, I remain prepared for the mountain climber’s (risk assets) fall.

I hope everyone is having a wonderful earnings season! I have a growing backlog of topics I want to discuss and will hopefully be posting again in a couple weeks.