Who to believe on the economy: bonds or data?

The U.S. economy seems relatively healthy. Job growth, considered the most important driver of economic activity, has been robust over the last several years, with the unemployment rate falling below 5%. When slack leaves the labor market, increased competition for skilled workers is supposed to put upward pressure on wages. As rising wages lift the economy, interest rates are expected to climb as demand for capital increases. But neither of those things have happened, flummoxing U.S. central bankers otherwise eager to normalize monetary policy.  

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Meanwhile, despite December’s Fed interest rate hike, bond yields in the U.S. and around the world have plummeted so far this year amid concerns about slow growth and excessive debt. Before bonds sold off in Friday's equity rally, the U.S. yield curve had flattened to its narrowest point (less than 100 basis points) in eight years. Yields on the 5-year U.S. treasury were extraordinarily volatile late in the week, covering a 24 basis point range from Thursday morning to Friday’s close.

While the yield curve is still a ways away from inverting, a flattening yield curve still indicates the market believes odds of the U.S. economy falling into recession are growing. The response from global central bankers has been to double down on dovish monetary policies, which has had less incremental positive impact while spawning unintended, destabilizing consequences.  

A lot of negativity 

The financial media did a lot of negative interest rate-'splaining this week regarding the counter-intuitive nature of paying people to borrow your money.
 
The simple rule at the heart of finance is being broken, via Quartz:
 
“If you lend somebody money, they have to pay you back with interest… No longer. With central banks pushing the limits of their ability to stoke growth, interest rates on many bonds are in negative territory, effectively turning the core rule of finance on its head. When investors buy bonds with negative interest rates, they’re agreeing to pay a borrower to take their money.”
 
Negative interest rates are spreading across the world. Here’s what you need to know, via The New York Times:
 
“When you lend somebody money, they usually have to pay you for the privilege. That has been a bedrock assumption across centuries of financial history. But it is an assumption that is increasingly being tossed aside by some of the world’s central banks and bond markets.”
 
Negative interest rates were once just “theoretical curiosity” of economists, but have now become ironclad policy for several major central banks. As a result, there are now around $7 trillion in negative-yielding bonds around the world, representing around 30% of the Bloomberg Global Developed Sovereign Bond Index, with that number expected to rise as Japanese bond yields continue to fall.
 
Don’t necessarily hold your breath for negative rates in the U.S., though. In Congressional testimony this week, Janet Yellen questioned whether the Fed even had the legal authority to essentially charge interest on bank reserves.
 
The whole concept seems to have disrupted every tenet of the global economic system, and the worrying action in bank stocks this week perhaps represent the gravest externality.  
 
Bank distress comes to a head
 
Banks lost an income stream when they were forced to rid themselves of proprietary trading desks after the financial crisis. After a mediocre two years of equity performance, investors are pulling money from wealth management divisions at a rapid clip. And now, with several major central banks adopting negative interest rate policy (NIRP), banks are in some cases losing money on deposits, too. Poor banks. At least accountability on Wall Street has improved to the point embarrassed CEOs are voluntarily giving back their bonuses. 
 
By the middle of last week, selling in several major European banking stalwarts began accelerating at alarming rates. Several had lost half their value year-to-date. Deutsche Bank, by far the largest and proudest bank in Germany, a country with a reputation for fiscal prudence, saw its equity and debt trade like that of a company on the brink of crisis. On Tuesday, Deutsche Bank credit default swaps (CDS), which measure default probability, spiked to levels not seen since 2008. 

Reassurances from management during the week did little to meaningfully stem the tide. The company's stock and bonds finally popped Friday, though, when management announced plans to buy back $5.4 billion of its own below-par debt, using excess liquidity to boost its capital position. The announcement triggered a 12% rally in DB stock and lifted the entire European banking sector.
 
J.P. Morgan also played a major role in Friday’s bank comeback. It's considered one of the better-capitalized American banks, but even its equity was down around 20% so far this year. But after the close Thursday, CEO Jamie Dimon announced he had spent $26 million of his own money to buy 500,000 shares of the company’s stock. The cheeky move triggered a more-than 8% rally in the stock Friday, netting Dimon a, immediate $2 million paper profit.
 
The two confidence-boosting moves lifted short-term sentiment in the financial sector, but questions remain about banks’ ability to cope with the implications of low global growth and negative interest rates, not to mention the possibility of an anti-Wall Street populist politician fear-mongering his way to the White House. Battered bank stocks don't necessarily reflect fundamentals, but rather an ongoing distrust of Washington. 

Compounding the misery of plummeting oil prices in the Middle East is the fact financial stocks make up a large percentage of equity holdings in Persian Gulf sovereign wealth fund portfolios. 

Oil and the market have become star-crossed lovers
 
This weekend’s Saint Valentine-inspired Bloomberg Businessweek cover story labeled oil the “Cheap Date From Hell.” The fact is nobody can really make sense of the broader implications of this spectacular, unprecedented unwinding of the greatest commodities super-cycle of all time. While cheap oil puts a strain on a major sector of the U.S. equity market, it also acts as a stimulus package for consumers. While cheap oil threatens to put American shale producers out of business and roil the high-yield bond market, it disproportionately weakens the economic position of several U.S. geopolitical adversaries. Which begs the question, is this a global stock market rout worth celebrating?
 
Perhaps the biggest elephant in the room is the effect an inevitable wave of bankruptcies will have on bank balance sheets already reeling from a confluence of factors.
 
No hiding in technology stocks
 
As the Fed embarked on its interest rate tightening cycle late last year, conventional wisdom said to buy bank stocks, due to higher margins on deposits, and technology stocks, due to the relative attractiveness of growth in a rising interest-rate environment. Instead, those two sectors have been among the hardest hit in this year’s unforgiving market.
 
Last year, the much-celebrated FANG stocks – Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google (GOOG) – dramatically outpaced the market with average gains of 73%. But so far this year the fearsome foursome is collectively down around 20%. The mean reversion is part of an overall trend that has seen stocks with high price-to-earnings (PE) multiples get punished more severely in this year’s selloff.  
 
Unicorns pulling up lame
 
It’s only natural that a higher standard for growth stocks in public equity markets has also spilled over into private equity valuations. The sickliest unicorn recently has been Zenefits, the San Francisco-based venture capital darling that raised money at a $4.5 billion valuation last year. The company offers free human resources tools to small business, making money in a broker capacity when its clients purchase healthcare for employees. It appears moving fast and “breaking things,” as hackers like to characterize innovation, within highly regulated industries can come with its share of problems.
 
Zenefits founder and CEO Parker Conrad was forced to resign this week after revelations that the company had created a secret software tool allowing sales reps to fake the completion of an online course required to get a license to sell health insurance. Buzzfeed found that more than 80% of Zenefits’ insurance deals in Washington state through August 15 were done by unlicensed employees.
 
In other news...

Voluntary job quitting hit its highest level in nine years, yet another typical sign of a strong labor market. Millenials would rather spend money on vacations than save for retirement.

Bespoke put together an informative chart outlining S&P 500 performance by sector since the market bottomed in March 2009. The index is basically flat since the end of 2013.

Argentina, after agreeing to a deal with a one group of holdout creditors, has asked a judge to reconsider his injunction preventing the government from paying creditors before agreements have been reached with all holdouts. Meanwhile, the company is still negotiating a settlement on its worst bonds.  
 
While Facebook looks on course for world domination, Twitter struggles to become more than just a niche social network. But instead of overhauling the product and alienating its core users, Twitter should embrace life as a beloved social utility, according to New York Times technology columnist Farhad Manjoo. 
 
Kyle Bass discussed his bearish thesis on the Chinese yuan currency on Wall Street Week back in January, and this week he released a detailed presentation on why he thinks China’s banking loss cycle could be four times bigger than the financial crisis.
 
Vanguard’s low fee mutual funds have put downward pressure on management fees in the entire industry, but a wannabe whistleblower says the company’s structure violates American tax law. The claims have been taken somewhat seriously, but Bloomberg View’s Justin Fox explains why the case could ultimately fall apart.
 
You are owed nothing from financial markets, but when stocks go on sale, here’s how you should be thinking.
 
Conversations about monetary policy seem so small when you read about a collision between two massive black holes, producing never-before-recorded data and lending credence to Einstein’s 100-year-old theory about space-time bending gravitational waves.