Brace for a market sell-off as the futures market is pointing to a more than 50-point drop on the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index due to growing fears of a global growth slowdown.
It's too early to use the "R" (recession) word in my view although bond markets are pricing one in – and that's bad news for risk assets.
ASX investors should be sitting up and paying attention as the stellar circa 10% gains on the ASX 200 could unwind quickly if bond traders are on the money.
Leading the gains among the large caps in 2019 have been the Fortescue Metals Group Limited (ASX: FMG) share price, Santos Ltd (ASX: STO) share price and the QBE Insurance Group Ltd (ASX: QBE) share price.
Inversion perversion
There are two events on bond markets all ASX investors need to be aware of. The first is the inversion of bond yields. History has shown this to be one of the most reliable predictors of a recession in the next 18 months.
An inversion happens when the yield on a short-term government bond rises above the longer-term bond.
This is abnormal because time is considered a risk factor. The longer investors have to wait to get their money back (at the maturity of the bond), the more they should be compensated.
This means the yield on a 10-year bond should be higher than that of a six-month bond, but that isn't the case for US government bonds (called Treasuries).
The yield on the 10-year Treasury has been falling and is now at a more than one-year low of 2.44%, while the six-month Treasury yield has rallied strongly over the past year to hit 2.46%.
Negative bond yields
The other significant event to happen on global bond markets is the German government bond (or bund) falling into negative territory.
It sounds crazy but bond yields can fall below zero although that tends to only happen in extreme circumstances, like during the GFC.
The two-year bund is sitting on -0.58% while the 10-year bund is just under breakeven. This means investors are effectively paying the German government to safekeep their money!
It's telling that the shorter-term bund is deeper in the red. It does reflect that my earlier point about time being a risk factor, but it also shows that investors are more nervous about the nearer-term outlook for the German (or EU given Germany is the largest member of the bloc) economy.
Poor EU manufacturing data is exacerbating investor angst. The HIS Markit flash eurozone PMI paints a gloomy picture with manufacturing output tumbling to a 71-month low while forward looking indicators are hinting at a deepening slowdown.
Let's hope these bond market disaster signals will reverse in the next week or so. Otherwise, I would be looking to trim my overweight exposure to risk assets.
