The Daily Prophet: Stock Market Suffers Bout of Bad Breadth

Connecting the dots in global markets.

After yesterday's white-knuckle ride in stocks, investors spent much of today trying to make sense of what was the biggest drop in U.S. stocks since October. Although there are just as many who say the move foreshadows the start of something ominous as there are who say it's just a temporary setback in the continuing bull market, the reality is that the debate has exposed an uncomfortable truth about equities.

Largely lost in the headlines about stocks at records before the selloff is the fact that the advance has been led by just a handful of large, mostly technology companies (think Apple, Amazon, Google and Facebook), while the shares of smaller companies are actually down for the year -- a phenomenon the folks at Convergex Ltd. call "bad breadth." The divergence is notable, they say, because smaller companies generally get a greater portion of their revenue from domestic sales and ideally would benefit the most from the Donald Trump administration's policies. Yes, small companies' shares did outperform wildly last year, but their recent showing may be a sign that this year's rally wasn't built on a solid foundation. 

The current bout of turbulence "doesn't mean we're not going to have some sectors do well and others do poorly, but overall it's hard to be super-bullish at these kind levels," Andrew Wilson, chief executive officer at Goldman Sachs Asset Management International, said in a Bloomberg Television interview.

Someone forgot to tell bond traders that they are supposed to sell bonds when the Federal Reserve raises interest rates. The benchmark 10-year Treasury note rose again today, meaning it has now advanced in five of the six days since the central bank boosted rates. In fact, the Bloomberg Barclays Global Aggregate Index has gained 1.50 percent since Dec. 13 -- the day before the Fed raised rates that month -- through yesterday. That may not seem like much, but it's pretty good when you consider that the S&P 500 Index rose just 3.18 percent in the same period. When you consider risk-adjusted returns, the performance is even more impressive. The reasons demand persists range from investors seeking a safe place to park cash amid recent jitters in the stock market to signs that inflation is in no jeopardy of accelerating with the recent drop in oil. The bond market has consistently surprised the naysayers in recent years. Why should 2017 be any different?|

For those keeping score, America's currency has now fallen for six straight days as measured by the Bloomberg Dollar Spot Index, the longest slump since the very beginning of November. The gauge has dropped 4.7 percent from its post-election peak on Jan. 3. Of the 31 major currencies tracked by Bloomberg, the dollar has only gained in that period against the Hong Kong dollar and the Turkish lira. Strategists say that a lot of the dollar's weakness in recent days can be tied to what's happening in the bond market. As yields on U.S. debt securities fall, their appeal to global investors relative to what they can get elsewhere with stronger currencies diminishes. The upshot of a weaker dollar is that U.S. exporters become more competitive.

As if investors didn't have enough to worry about, now come some alarming signals from China. For the third straight day, the nation's central bank had to inject funds into the financial system after the benchmark money rate climbed to its highest level since April 2015 and some smaller lenders failed to make debt payments in the interbank market. The People’s Bank of China pumped in a net 40 billion yuan ($5.8 billion) on Wednesday, taking net injections so far this week to 110 billion yuan. The institutions that missed payments included rural commercial banks, according to traders who asked not to be identified. "Non-bank institutions and smaller banks will find it much harder to borrow money after the incident," Harrison Hu, chief greater China economist at Royal Bank of Scotland Group Plc in Singapore, told Bloomberg News.

Many investors question the veracity of official economic data coming out of China, so they have taken to outside metrics to gauge the health of the world's second-largest economy. One of those key measures is flashing red. Iron ore is in retreat as doubts gather about the strength of demand in China as steel sells off and record port stockpiles put a spotlight on rising supplies, according to Bloomberg News's Ranjeetha Pakiam. In China, futures on the Dalian Commodity Exchange sank into a bear market as steel in Shanghai posted the longest run of declines this year. Iron ore surged last year and those gains extended into 2017 amid optimism about the outlook in China, benefiting miners including Rio Tinto Group, BHP Billiton and Vale SA.

Investors will hear from Fed Chair Janet Yellen for the first time since she gave a news conference following the Fed's decision March 15 to raise interest rates. Yellen is due to give the opening speech at a Fed community development research conference in Washington. As the bond market shows, investors are wondering more and more why the Fed is still thinks it can boost rates two more times this year even after making no real change to its forecasts for growth and inflation. If the recent turmoil in stocks continues, bond traders will surely start discounting future Fed rate increases.

Time to Rethink Market Strategies That Have Worked: Mark Grant

Look Past Oil to China for Clues to Commodities: Jason Schenker

Trump Is Endangering His Own Economic Agenda: Barry Ritholtz

Give Companies Easier Access to Public Markets: Cromwell Coulson

Debating American Complacency: Tyler Cowen and Noah Smith

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