Tell me if you’ve heard this over the last ten years:
“The economy of [X] is more dependent on debt than ever before”
“Companies are issuing record debt to buy back stock, this will end badly”
“Debt is too high and the [economy/markets/savings/wealth] will [explode/implode]”
“The Bond rally is telling us something bad is coming”
Extra points if you’ve heard all of these from a market guru, famous economist, TV personality, ivy professor promoting a book, or ex-hedge fund manager with a blog.
Let me start by saying that markets don’t operate on absolutes. I’ve been trading for 25 years. In the arena every single day. In the middle of this organized chaos, I hear academics every day, taking turns shouting from the gilded seats, trying to be the one who predicts what happens next (always loud and full of confidence).
There is a simpler truth to markets. One that academics/noise-makers cannot grasp, yet all successful traders inherently understand: Sometimes things matter, other times they don’t.
A trader’s goal should be to constantly discard everything that doesn’t matter, so that what’s left is essential.
Let’s try this now, using a historical chart:
Top panel, S&P and 10-Year Yield. Bottom panel, 1-month Net Change in 10-Year Yield (2006-2019).
Now let’s add vertical red lines for every time the 10-Year Yield rises significantly over a 1-month period:
Looking above: see the spike in Yields in June 2007? That was the largest since 2004 (not shown). How about mid-2013, the Fed doing QE3/Infinity but the S&P still traded sideways from May to October, because Yields spiked three different times? Or 2015, Yields spiked twice and Stocks traded sideways for a year. Or most recently in 2018, Yields spiked in January & September and Stocks collapsed both times.
(Also notice above, how spikes have become far less frequent since 2013.)
Nothing works 100% of the time, and Yields have spiked on occasion with Stocks moving higher anyway (2016 a prime example). Nevertheless, over the last 15-20 years, rising Yields are usually bad for Stocks.
Now let’s add vertical green lines for every time the 10-Year Yield falls significantly over a 1-month period:
Recently on June 3 2019, Stocks may have formed an important bottom, after 10-Year Yields fell -47bps over the prior month. In the last four years, only one day had a bigger 1-month net drop in Yields: February 10 2016 (-51bps), which was the day before Stocks bottomed.
Once again nothing works perfectly, but Stocks generally do well after Yields fall sharply. So let’s go back to the start: is the recent Bond rally telling us something bad is coming?
Maybe.
Or maybe despite the loud chorus of sideline crisis-callers, the Bond rally may have just saved the economy (and the Stock market) yet again.
For this entire Bull market, yield declines of this magnitude have created huge runways for Stock prices to recover.
Bull trends die from inflation scares, not disinflation scares. Some of the biggest Stock corrections in recent years came after Yields rose sharply.
Equities love low-inflation/disinflationary growth. If there’s one “truth” in investing, this could be it. Disinflationary growth has kept this Stock Bull market plodding along for longer than anyone thought possible.
For more than a decade since this Bull market began, Stocks have been repeatedly hit with disinflation scares (mostly due to the Dollar rallying, like this year). Those scares pushed Yields sharply lower, clearing the way for Equities to recover, eluding the crash-callers each time. This latest Bond rally could rekindle the same old Bullish force for Stocks, right when the academics are rushing to call it a bad omen yet again.
Thanks for reading!
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