Good Friday AM,
Thank God this week is coming to an end.
I don’t think the pain in the markets is over (mostly over in bonds, but not close yet in equities) so we need the weekend to change the bandages and get ready for some more bruises. Just the anticipation of Powell opening his mouth is enough to break the market out in a cold sweat. This Fed will easily go down in history as the most destructive and careless in history. The 10-yr sits at 3.70% as I type. On 8/3 we were at 2.67%. Give that a moment to sink in. The next resistance level for the ten-year is 3.91% and I see nothing from a technical analysis to stop that from happening in the current environment. In the Mortgage Bond market, there is not much to stop the bleeding as well. The only thing that can save us COULD be an incredibly low PCE numbers next Friday and even then, one month of good numbers will not be enough. Keep playing defense until we get some sign of a bottom.
Here is a good piece from Bloomberg on bonds vs, stocks..
Despite the bond traders being smarter, there is more upside in trading equities. When equity investors migrate into bonds, that is not a good sign for the market. As such, stocks are down 20% from this year’s high (and some are calling this half time).
Bond yields are the most attractive relative to stocks’ earnings yields in at least a decade, a blow to the “no alternative” mantra that dominated markets for much of the last decade. But before that, it used to be the norm, and whether bonds will beat stocks largely depends on your view on where the economy is headed.
Different iterations of the so-called Fed model, which compares bond yields to stocks’ earnings yields, show equities are least appealing relative to both corporate bonds and Treasuries since 2009 and early 2010, respectively. This signal is getting attention among investors, who can now look to other markets for similar or better returns. That’s seen as a threat to stocks.
But this model has a mixed track record. Going back to 1990, whenever the spread between the average investment-grade bond yield and the S&P forward earnings yield was narrower than today’s level, total equity returns outperformed on an annual basis more than half of the time. The ratio is better when compared against Treasury yields. Results don’t significantly change when looking at the times when the gap turns positive.
A notable pattern, however, is that equities tended to underperform during economic downturns. When the yield spread was narrower than today, S&P returns lagged corporate bonds in the first year of the three recessions (1990, 2001, 2008) captured by this study, and in two instances when compared with Treasuries (the yield gap was wider in 2008).
Of course, caveats apply, mainly that inflation wasn’t running as fast during the period analyzed in this study. So a look at the Great Inflation period is warranted; however, that can only be done on a current-yield basis for the S&P.
During the early 1980s, the last time price growth was running as hot as today, stocks surprisingly beat bonds even amid a recession but then lagged for the following two years and didn’t start consistently outperforming until 1985 as inflation and rates came down materially.
Of course, earnings estimates remain a big question and weekly downgrades have outpaced upgrades since June, according to a Citi index. FedEx’s recent profit warning is alarming.
Some of the concern is already reflected in the price but a lot of it isn’t, analysts from Goldman to Morgan Stanley say. That said, hiding in bonds hasn’t always been the winning strategy even as yields surge on central bank tightening. Only if you think we’re headed for a downturn soon.
Please remain safe and stay healthy, enjoy the weekend and, first, make today great!