Financial Markets Weekly: May 26th

May 31, 2018

Here’s your financial markets weekly report for May 26, 2018.
Hoping everyone had an enjoyable Memorial Day weekend. Spent a bit of time remembering our fallen heroes. And reveling in the idea that summer has arrived.
And while spring showers will soon give way to sunny summer horizons, investors should beware. As some pundits believe the U.S. stock market may be in for a summer storm.
On the surface, things look reasonably placid. Despite last week's volatile geopolitical events (e.g. trade war, Trump and North Korea, Italian bonds/government), markets remained strong. Underneath that positive surface, however, resides some real bearishness.
The average stock in the S&P 500 is underperforming the market by nearly a whole percent. While the S&P 500 is up three percent this year, the average stock has gained just 2.1 percent, showing that market breadth has narrowed. Which bodes ill for equity indices. As one of the bearish indicators typically occurring prior to a major correction is a negative advance/decline reading. Where stocks continue to elevate or trade sideways, even as more share prices fall than those heading higher. Such a condition reveals weakening market breadth. And typically precedes a move lower.
That said, the market will be forced from its indecision sooner than later. As the S&P 500 has furrowed itself into a wedge-consolidation pattern that eventually forces the underlying index to move higher or lower.
In geopolitics, it appears that the U.S./North Korean Denuclearization Summit could be back on. And the pending resumption of economic sanctions is on hold. Though we won't be counting those chickens till they hatch. Still, N. Korean strong man Kim Jong-un's right-hand man is scheduled to arrive in the U.S. this week under the auspice of continuing to lay the groundwork for a potential June 12th summit in Singapore.
General Kim Yong-chul has long been in the thick of intrigue wherever North Korea is concerned. The former head of military intelligence was allegedly the mastermind behind the Sony hacking related to the movie "The Interview." As well as attacks on the South Korea warship Cheonan and Yeonpyeong Island in 2010.
Kim's appearance marks the highest level North Korean visit to the U.S. since 2000. Check out the BBC's profile of the general, here.
Staying in Asia, the Trump administration sent a brash message to Beijing: The U.S. is moving forward with tariffs on Chinese imports and restrictions on China's access to sensitive U.S. technology. The White House will announce a final list of $50 billion in targeted Chinese imports by June 15. Planned investment restrictions are due by June 30. The move came as a surprise to Chinese officials. Given that the White House had for days suggested it would put such measures on hold during negotiations to narrow the $375 billion annual trade gap between the countries.
Perhaps the move was made for negotiating leverage. Or to simply make the point that this administration is through with Chinese stalling tactics that ensure nothing is accomplished while Beijing reaps the whirlwind of its trade surplus. Not to mention its ongoing thievery of western intellectual property. Either way, it's good to see a hard stand being made. As the only position the Chinese seem to recognize is one of strength.
In Europe, Italy's political situation continues to roil an increasingly fragile Union. March's electoral victory by two populist anti-EU parties has prevented the establishment of a coalition government and could force another round of elections later this year.
Meanwhile, Italy's escalating debt situation requires immediate solutions. Problematic, given the country's inability to appoint an economics minister. Italy's debt is more than 130 percent of its gross domestic product. Rendering it the most indebted European country behind only Greece. And unlike many of its eurozone peers, Italy's economy remains weaker today than it was before the last crisis.
Italian two-year bonds have shot from offering negative yields to yielding 2.77 percent virtually overnight. A shocking move given the typically glacial pace of debt markets. Where a move of that size typically takes years. Shock waves resonated throughout the Italian economy. Having brought European finance minsters to shudder at the consequences should Italy spiral into a deeper debt crisis.
Traditionally, bonds represent the boring end of the investment spectrum. So, when such instruments -- especially those of a sovereign government -- make such volatile moves, it can only indicate a real sense of fear on behalf of bond investors who have essentially demanded much higher yields to compensate for the perceived risk of buying and/or holding such instruments. Something wicked this way comes...
Not that the world isn't perfectly acclimated to Italian political crises. Silvio Berlusconi ran the place like his personal carnival for years. But this comes at a sensitive time for the EU. And, if push comes to shove, an Italian exit (Itexit?) from the EU would be standard deviations more harmful than Brexit.
For Europe, this Italian goat rodeo represents a self-reinforcing catastrophe: Lower sovereign bond prices (and thus higher yields) weaken bank stocks and bonds, resulting in a pullback in lending and capital market losses. Which in turn weakens the economy. Lowering tax revenues. Which further lowers government bond prices and raises borrowing costs as politicians are forced to consider bailing out their banks. Underscored by the realization that the situation can only get worse before it gets better. And whereas the EU was able to navigate Greece's crisis five year ago, Italy's economy is eight times larger. And its bond market, because of its indebtedness, is the world's third largest. Making this a much bigger pill to swallow.
Of course, Italy will contend that it can batten down the hatches and reign in its spiraling debt concerns. Which, quite frankly, sounds about as plausible as a Wells Fargo apology ad. We'll stand by the old John Michel dictum: watch what they do, not what they say.
The entire house of cards brings me back to another recent Southern European debt crisis. Athens, Greece. Summer of 2011. Protesting against austerity requirements mandated by the Northern European Industrial Overlords, the Greeks spent the summer gnashing their teeth, lobbing Molotov cocktails at government buildings, and making headlines. And why don't these things ever occur during the winter? Perhaps Mediterranean mobs refuse to angrily take to the streets until its just a wee bit warmer...
Still, domestic markets long ago learned to acclimate to foreign financial and economic turbulence. Though caterwauling headlines will bring otherwise prudent investors to feign nervous tension in the weeks ahead, equity markets will soon enough digest Europe's current crisis. Seeing it for what it is -- foreign economic woes. And then returning to the business at hand: risk, reward, earnings growth and the fundamental merits of prospective opportunities.
Stay tuned for your next financial markets weekly update…
Financial Markets Weekly Recap
Major indices finished higher last week. The DJIA gained 0.15%. The S&P 500 rose 0.31%. The Nasdaq climbed 1.08%. While small ap stocks gained 0.02%. 10-year Treasury bond yields fell 12.5 basis points to 2.932%. While gold closed at $1,301.7, up $9.70 per ounce, or 0.70%.
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