Market Insider

There's something weird going on that's worrying the markets

Key Points
  • Markets are showing signs of nervousness, which analysts say is not necessarily the dire warning some fear.
  • There is concern that the bond market is sending warnings about the economy, as high yield debt sells off and the Treasury yield curve flattens.
  • The yields of longer duration bonds are getting closer to the yields of shorter duration bonds, and some see that as a forewarning about a slower economy.
These red flags are lurking below a market at record highs
These red flags are lurking below a market at record highs

There's an odd chill in the air on Wall Street, but many analysts are shrugging it off as a temporary cooling of a market that still has room to run.

Continuing a choppy trend of the last several sessions, stocks Tuesday seesawed and closed lower. The dollar weakened, as commodities like copper and oil sold off. The high yield debt market was under pressure, as buyers moved into safety at the long end of the Treasury curve.

"We're just taking a little bit of a break," said Art Hogan, chief market strategist at Wunderlich Securities.

The stock market hiccupped in morning trading, with the Dow dipping nearly 170 points, but it later closed down just 30 at 23,409, its third loss in four sessions. Traders blamed the mid-morning move in bonds and stocks on concerns that tax reform may not make its way through Congress successfully. The House votes on its version Thursday, and the Senate is still ironing out its version.

"People are just saying there's jitters about tax reform," said Marc Chandler, the head of foreign exchange strategy at Brown Brothers. "Going into the year-end people are nervous. lt's not only about taxes."

The cranky mood began in China and Asian markets overnight, after Chinese economic reports missed the mark. There was also a jump in Chinese bond yields, with the 10-year temporarily hitting 4 percent, a three-year high.

"As for the junk bond sell off last week, it was very narrowly based. It was low valued credits and telecom," said Chandler. "Most people I talk to are not convinced taxes are going to be passed this year." Chandler said Congress has little time after the Thanksgiving break to get the bill passed by year end.

Hogan said Congress, nonetheless, is making progress on a bill.

However, one of the nagging issues for the stock market has been the flattening of the yield curve. Hogan said the market is nervous about the "flattening" difference between the 2-year yield and the 10-year Treasury yield, which have been moving closer together. The curve dipped to 68 basis points Tuesday, a 10-year low. Hogan said 70 has become a line in the sand, and when it falls below that traders get nervous.

A flattening curve can signal that the curve will invert, which historically means a recession is on the horizon. But Hogan dismissed that and said there's less than a 20 percent chance for recession next year. The move is more to do with the rising , which was as high as 1.69 percent Tuesday.

"We have a Fed that's locked and loaded and ready to raise rates in December and probably be on a path for three rate hikes next year. That's affecting the 2-year," said Hogan.

Peter Boockvar, chief market analyst at Lindsey Group, said the market could also be anticipating tighter monetary policy next year when the Fed continues to pare back its bond buying and the European Central Bank also slows its purchases.

"You're talking about $165 billion of less liquidity, just in Q1 alone. This has not been an earnings driven market," said Boockvar. "Every day we get closer to 2019, we get closer to that liquidity flow turning into more of a drip."

Boockvar and others say the markets are also getting antsy going into year end, worried that the high yield market is signaling broader concerns about credit. There was some chatter about asset allocation programs influencing trading.

""In this kind of crazy market, as we head into 2018, anything is possible. If we do sell off, it's going to get exaggerated," he said.

The S&P 500 is up 15.2 percent year-to-date, and at 2578, it's just about 20 points off its high.

Commodities markets were also on the move Tuesday, with copper reacting to China growth concerns.

Copper futures for December fell 1.7 percent to $3.065 a pound on concerns about growth, after the China data. Oil also slumped, with West Texas Intermediate futures losing 1.9 percent to $55.70per barrel. Oil slid on a gloomier demand outlook from the International Energy Agency, which also was upbeat about growth in U.S. oil production and exports.

"It shows a lack of risk appetite," said Bart Melek, head of commodities strategy at TD Securities. "Oil got ahead of itself so it's responding to concerns shale is going to grow more rapidly."

Markets could react to CPI and retail sales data Wednesday, both released at 8:30 a.m. ET. There is also U.S. government oil supply data, released at 10:30 a.m. ET.

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