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What Goes Up Must Come Down

Stocks continue their pull back from all-time highs. It looks like a short-term peak was achieved, which sets up a decline that should last for at least the next few weeks. The key now is where this next low is made. We will refrain from providing our ideal support levels in this column, and instead share them in the next Mercator Letter, which is set to come out this Sunday, February 2.

Various financial pundits are claiming the market is off the highs due to the threat of the coronavirus. But what about the fact that equities rallied for nearly 4 months straight? The fact of the matter is, stocks go up, down, and sideways. It is all part of a cycle. Contrary to what's predominately taught in modern economics, there is no linearity in markets. Infinite growth is not achievable, nor should it be the goal. It is contrary to the principles of nature, and we would be wise not to tempt nature itself.

So now, we have part of the yield curve inverting again. Specifically, it is the 3-month metric, which measures the difference between the yields in the 10-Year Treasury and the 3-Month T-Bill. What this means is the 3-Month T-Bill is paying more interest than the 10-Year Treasury. Think about that for a second: Why would you invest your money for 10 years if you can invest it for 3 months and achieve a higher return? You wouldn't, which is why this is a warning signal from capital markets to investors. But just because this metric inverted doesn't mean the party's over. The yield curve usually has to be inverted for months on end before it becomes a serious precursor to a recession.

Back to the coronavirus. It's worth stating outright that the current mortality rate is less than 3%. That being said, viruses can and do mutate, but for the time being, it appears the main concern is the transmission rate, which is at 2-3 new infections per individual case. The main reaction we've witnessed from markets is interest rates moving lower (bonds higher). Interest rates tend to be a reflection of the rate of economic growth, so there clearly is some concern of an economic slowdown by bond investors.

The key is whether the current interest rate trajectory will continue. As of this writing, interest rates are close to taking out their lows from last year. Keep in mind it's only January, but also, it's worth remembering that we are in an election year too. In 2016, interest rates fell for most of the year, before forming an impressive bottom and then rallying very strongly to end the year. Perhaps something similar is in store for 2020.

Of course, other markets are moving too, and not necessarily in response to the virus outbreak. All markets are connected in some way or another. Capital, like matter, is never created or destroyed. It merely transfers back and forth between various sectors and asset classes within the market. But the best part is that it does so in a divine, mathematical order; one that we love to observe.

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