There Will Be Days Like That: It was a bad day for stocks yesterday with theDow Jones Industrial Average dropping 799 points. That’s the fourth- biggest point drop in the 119 years or so of data that we checked. The 3.1 percentage-point decline also falls in the worst 1.1% of all trading days. U.S. markets are closed today to honor the passing of America’s 41st president, George H.W. Bush, but futures for the Dow, S&P 500, and Nasdaq Compositewere all modestly higher. In today’s Morning Movers, we…
- …Define contango;
- …Define inversion;
- …and tour Europe.
- Contango? Contango is a term in commodity markets that means the futures curve is upward sloping. That is to say, you pay more for soybeans in July 2019 than you do in January 2019. It’s how the market gets paid for storing commodities. It’s also one of the reasons that commodity ETFs tend to underperform their underlying commodities. With contango, ETFs have to pay a little more when they roll forward the futures they hold. Don’t forget futures contracts expire. If you don’t want to take physical delivery of a bushel of soybeans you have to sell one contract and buy anther. ETFs tend to get a little less commodity for the same amount of money as time goes on. Backwardation is the opposite situation. It’s when January soybeans are is more expensive than July deliveries. The market is sending a signal to commodity producers in this situation. Do not store product—the market wants it now.
- Bond Inversions: Why did we talk about contango and backwardation? It was really a lead in to the topic of bond-yield inversion. The yield curve is usually upward sloping. It costs more to borrow money for five years than it does for two years. It’s how capital providers get paid for parting with their money for longer periods of time. The market gets very nervous when short-term yields exceed long-term yields. That’s supposed to be a predictor of a recession. The signal to the marketplace is that credit is expensive now and cheap in the future. That can be interpreted as things are slowing down. Another problem with inverted yield curves is that they are brutal for banks. Banks borrow short-term money and lend for long periods. You can’t make it up on volume if your short-term borrowing costs are higher than what you earn lending that money out. The S&P Banking and Regional Banking Indexes are down 19.3% and 20.3%, respectively from their 52-week highs. That’s bear-market territory. Where are we now? The 2-year Treasury bond yield is now above the 5-year yield and the 2-year yield is really, really close to the 10-year yield. Investors are wary.
- Around the World: European banks are also hurting. They are down 33% from their 52-week highs. And European stocks have followed U.S. markets lower this morning. Financials, energy, industrials and technology shares were all down more than 1% in afternoon trading. Some good news. Bayer (BAYRY) was upgraded at DZ Bank. The company recently said it was cutting 10% of its global workforce and selling its animal health division.