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Bonds paint a hard-landing scenario for stocks
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Equities are unfazed by hotter-than-expected inflation prints
There is a saying that all good things in life are free. This could be
accurate for spending time with family and close friends, but certainly
not for money.
The US Federal Reserve held rates in the aftermath of the Great Financial
Crisis 07 – 09 for nearly 14 years to stimulate the economy in what became
known as “zero-interest rate policy” or “ZIRP.” During that period,
productivity was low, growth mild, and leverage excessive, contributing to
widening wealth inequality.
Now that the Fed has moved to a “higher for longer” stance to slay the
inflation beast it created in the first place from that protracted period
of abnormally low rates.
Today, we’re examining the impact of the sharp increase in U.S. and
global interest rates on stock market valuations.
The relentless rise in 10-year Treasury yields in the last two years, from
0.7% in August 2021 to 4.9% just last week, following stronger-than-expected
jobs data. 30Y Treasuries reached levels not seen since the great financial
crisis of 07-09
Traditionally, rising yields are a worrying signal for potential economic
deceleration, which, as in a domino effect, will trigger a subsequent dip
in earnings per share (EPS).
The Federal Reserve is expected to continue raising interest rates to
combat inflation, which
could further dampen economic growth
in the coming months.
International Monetary Fund confirms that growth will be slowing in most
regions in its latest forecasts, citing
Tightening financial conditions in most regions.
This has led even the most seasoned equity analyst to scratch his head as
to why we’re experiencing a bull market instead of a bear one.
One explanation can be attributed to the insane fiscal deficits by the US
government that have kept the ball rolling for the economy and the stock
market.
Tech P/E’s are out of touch with Real rates.
There was a correlation between S&P 500 forward P/E multiples and real
10-year Treasury yields, although this trend has broken in the past year.
This was true until Autumn 2022 when things reversed course due to
AI-driven productivity hype, strong labour market, speculations of Fed
intervention to reduce yields, and renewed optimism about stock indices from
many Investment banks.
Keep an eye on real (and nominal) 10-year Treasury rates. Either they
need to come down a lot to validate existing forward P/E ratios, or the
latter need to experience gravity to play catch up to the former.
There has been a tremendous sell-off in the Treasuries market, over two
standard deviations below their mean! To put that into perspective, the
drawdown in long-term treasuries is worse than the drawdown in stocks
during the global financial crisis.
That oversold level has typically foreshadowed events such as the October
1987 crash of the Dotcom Bubble.
A similar situation is with almighty“TLT,”
the popular ETF is also -2 standard deviations below its mean.
However, TLT’s recent spike in volume could mean that traders have finally
woken up, as the bond bloodbath has caused the ETF to fall 20% in the last
six months and a staggering 50% down peak to trough since 2020. That dwarfs
in magnitude even the stock market nosedive after the dot-com bubble!
And certainly, there is no shortage of dip buyers, given the insane
call-option interest!
The market is adjusting to robust macro and stubborn inflation data, namely
manufacturing figures stronger than expected, job openings above
expectations, and on the inflation side, producer and consumer prices
exceeding expectations.
All that is causing the “higher for longer” rates stance by the Fed to cool
off the economy and bring down inflation to its 2% target.
Stock prices tend to fall when Treasury yields rise, as investors
become more risk-averse and demand higher investment returns.
So far, equities have held on remarkably well, especially in the face of a
looming economic downturn and bleeding bond market.
However, with the latest geopolitical conflict between Israel and Hamas,
spiking Oil prices, and hotter-than-expected inflation prints, namely PPI
and CPI, will only add more fuel to future inflation expectations and, with
it, downward pressure on the hefty equity valuations, especially in
overconcentrated equity indices such as the NASDAQ 100.
Investors can bet long or short on the long-term treasury market with
our TLT product
5x 20+ Year Treasury Bond
,
-5x 20+ Year Treasury Bond
.
Market participants might go long or short the US equity indices using
our
5x Long US 500
,
3x US 500
,
-3x US 500
.
Traders can also trade the tech-heavy NASDAQ 100 using our
5x Long US Tech 100
,
3x US Tech 100
,
-3x US Tech 100
.
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