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02-25-19 Market Commentary

U.S. equity futures are pointing to a positive open this morning, adding to the nice rebound stocks have had in the first two months of 2019. The Dow Jones Industrial Average closed above 26,000 on Friday for the first time since November. Both the Dow and the S&P 500 are up almost 19% since the Christmas Eve bottom.

The disconnect in the Treasury market seems to be growing. Back in November when the Dow was trading above 26,000, the 10-yr Treasury was almost 3.20%. With all the volatility in late December and early January, the 10-yr closed as low as 2.55%. Over the past two months, the 10-yr Treasury has only moved 12 bps higher to a 2.67% so although stocks have rebounded the 10-yr is still 53 bps lower yielding. The 2-to-10 Treasury spread has moved up a few basis points this year but it still remains at 16 bps, a 12 year low. The bond market is certainly painting a more gloomy picture than the equity market but time will tell which is right.

Equity investors can thank the Fed for the recent performance. Their shift to a dovish stance has caused interest rate hike probabilities to plunge. The highest hike probability at any of the next eight meetings is now just 2.2%. Furthermore, the recent Fed minutes suggest that almost all Fed officials are ready to put an end the balance sheet wind down. This would be an interesting turn of events because the Fed’s balance sheet (currently almost $4 trillion) is still massive compared to pre-Great Recession levels (typically less than $1 trillion).

The Economic Surprise index has plummeted the last few weeks, moving from -0.20 to -0.513.  This is now the lowest reading in almost two years. The same sectors continue to drag the index down. The Housing and Real Estate Market continues to be in negative territory. This could start to improve now that volatility is cooling and the 30-yr commitment rate is back around 4.00%.  The Retail Sale Sector has continued to struggle with a big surprise to the down side in February. On Thursday, 4th quarter GDP will be released.

There continue to be opportunities in the investment portfolio. Many clients have been focused on selling baskets of securities with little to no spread over Treasuries. While identifying securities with an aggregate breakeven is preferred, we have also been selling securities when the loss can be more than offset by the increase in interest income within the year.