Divergence Continues

The divergence between long-term Treasury bonds and stocks continues to keep going. The chart below shows how pronounced this divergence has become as the S&P continues to edge higher. Most times, these two will trade in tandem so the bond market is trying to tell us that the economy will remain in slow growth for longer. Not to mention that bankruptcies are rising as economic reality sinks into some sectors like energy. So, bond investors may be re-allocating where principal risk is guaranteed by the U.S. government.

The S&P 500 Index charted against 30-year Treasury bonds.

The are other conflicting signals as the price of gold is at all-time highs and commodities are rising in a sign that inflation may be percolating. Not a great thing for consumers as their purchasing power will get pinched with rising prices amid a severe economic contraction.

And the stock market ignores the reality of valuation. The chart below is a ratio of the Wilshire 5000 Index (the entire stock market) divided by GDP which shows we have surpassed the peak of the tech boom. The big difference today is that the central banks across the world continue to pump in stimulus which eventually finds its way into the stock market. The current state of the S&P needs a correction to remove some froth from the March low which may happen as we lead into the election. However, the continued stimulus is not going anywhere and could propel stocks higher for years despite the valuations. Where else do you go when interest rates are at negative real yields?

Perhaps the inflation monster will cause the Fed to reverse course but they are willing to live with elevated inflation for some time (they said so). I think we will see their mettle tested in the next year if commodities keep inflating. Until then, inflation largely resides within the stock market.

Chart of the Week!

Commercial real estate is still a mess as renters and landlords need to adjust rents to the new economic reality.

Economic & Central Banking Snippets 

  • The eurozone economy shrank at the fastest pace on record as gross domestic product fell by 12.1% from the prior quarter. “This figure confirms the enormous economic damage caused by coronavirus-induced lockdowns, which have left the bloc’s economy around 15% smaller compared to the end of 2019,” said Oxford Economics economist Rosie Colthorpe. “The recovery is set to be gradual and uneven, meaning we expect eurozone GDP to only regain its Q4 2019 level by mid-2022.” (FT)
  • Evidence the recovery has weakened in recent weeks: The number of workers applying for initial unemployment benefits rose for the second straight week—by a seasonally adjusted 12,000 to 1.43 million in the week ended July 25—after nearly four months of decreases. The number of people receiving unemployment benefits increased by 867,000 to 17 million in the week ended July 18, ending a downward trend that started in mid-May.
  • Germany’s GDP contracted 10.1% in the second quarter, its largest decline since 1970. 
  • Mexico’s GDP contracted 17.3%, its fifth fall in a row.
  • After three straight months of declines with most of the pain in April, core durable goods spending rose for a 2nd month by 3.3% after a 1.7% m/o/m rebound in May. (Boock Report)
  • US economy suffered its sharpest postwar contraction in the second quarter as gross domestic product shrank at an annualised rate of 32.9% as shutdowns closed businesses and left millions out of work.
  • Home purchasing is picking up as 30Yr interest rates fall and more people flee dense population centers for the suburbs.

Macro Snippets

  • California Pizza Kitchen filed for Chapter 11 bankruptcy in Houston on Wednesday, becoming the latest restaurant chain to try to cut debt as sales have evaporated. (Investopedia)
  • AstraZeneca said late stage trials of its COVID-19 vaccine developed with Oxford University are currently underway in the U.K., Brazil, and South Africa, and are due to start in the U.S soon. The company has mobilized research efforts to find new ways to help target the virus and reduce the hyperactive immune response and organ damage it causes. (Investopedia)
  • Sanofi and GlaxoSmithKline are receiving $2.1 billion from the U.S. government for the development, manufacturing and delivery of 100 million doses of their COVID-19 vaccine candidate. The Phase 1/2 study is expected to start in September. (Investopedia)
  • Google will keep its employees home until at least next July, making the search-engine giant the first major U.S. corporation to formalize such an extended timetable in the face of the coronavirus pandemic. The move will affect nearly all of the roughly 200,000 full-time and contract employees. (WSJ)
  • The dollar is on track to close out its worst month since April 2011 as a rise in coronavirus infections across the U.S. threatens to damp the economic recovery and keep low interest rates in place for longer. (WSJ)

That is all for now and thank you for being a subscriber!


Paul J. McCarthy

Paul J. McCarthy, III

President – Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.