Stocks declined this week while much of Florida prepares for one of the strongest storms on record to hit the mainland. The Dow declined 0.9% while the S&P 500 declined 0.6%.
While Irma headlines justifiably dominated the news cycle, there were some important financial developments this week as well. First, sources reported that President Trump is unlikely to nominate Senior Economic Advisor Gary Cohn to the Chair of the Federal Reserve. It was widely believed Cohn was well-positioned for the role and markets were eagerly anticipating his ascension into the role. Mr. Cohn is a former trader and #2 at Goldman Sachs. He lacks the academic pedigree of previous Fed Chairs, but many investors were excited to have an individual with significant market experience. In addition to the Fed Chair position, this report could signal the end of the Cohn’s role in the Administration. Cohn has been an important driver for tax reform, so his leaving the Administration could threaten that push. Read More
The 10-year Treasury bond approaching 2% was another important development this week. I’ve written about this a couple times in the last few months, but the yield on the 10-yr continuing to decline suggests the bond market doesn’t believe growth is improving in the US economy. Some of the rise we’ve seen in the stock market is predicated on the idea that overall economic growth will break out from our slump of the last 8-16 years. The 10-yr traded below 2% for eight months leading up the election in November, but rose sharply following Trump’s victory. Much of the enthusiasm in the bond market about Trump’s victory and what it meant for economic growth is gone. It is important to note that the bond market is notoriously pessimistic. There’s an old joke that the bond market has correctly predicted nine of the last five recessions, meaning it often signals recessions that never happen. I don’t believe we are nearing a recession, but the prospects for 3% annualized growth seem dim. Read More
One of the under-reported aspects surrounding hurricane Irma is the Florida insurance market. After hurricane Wilma in 2005, Florida implemented a lot of new restrictions and regulations on property insurance sold to state residents. As a result, many large insurance companies significantly reduced their exposure to the state. Smaller competitors popped up and many Florida residents have insurance through these smaller companies. A long stretch with minimal hurricane damage pushed premiums lower, creating a situation where insurance companies might be under-capitalized heading into this storm. Florida requires many of these small insurance companies to reinsure their exposure, some of which was done through catastrophe bonds. Catastrophe bonds are sold to large institutional investors. The bonds pay higher interest rates than government or corporate bonds, but also carry more risk. If there are no major claims situations, the investors make a good amount of money. However, a massive storm like Irma could see large losses on many of these bonds. Pension funds and other large investors are about to see whether they’ve been appropriately compensated for the risk they assumed. Similar to the mortgage crisis, I’m guessing many institutional investors are about to realize they have not been. Fortunately the catastrophe bond market is significantly smaller than the mortgage market. In addition to potential investor losses, this could set up a situation where numerous policy holders find their insurance company isn’t able to pay a claim. Read More
Oil increased this week, gaining 0.5% to close at $47.55/barrel. The yield on the 10-yr Treasury moved sharply lower, down 2.05% from 2.17% last week. The average rate on a 30-yr fixed continued lower to 3.78% from 3.82% last week. This is the lowest mortgage level of the year.
|10-yr Treasury (∆ in bps)||2.05||(11)||(39)|