Occasionally financial markets just make sense, which is how I was feeling through the late spring and early summer. The Fed and the federal government had both overstimulated the economy and financial markets with loose monetary policy and aggressive government spending designed to support the nation’s businesses and workforce as it emerged from the COVID-19 pandemic.
As a result, and as expected, interest rates went up, prices on raw materials and consumer goods went up, and the stock market, after a transition period, seemed to break out to the upside of the range it had been mired in since March. Everything was working as anticipated, even the volatility seemed orderly, oh, how validating.
Well, that didn’t last very long, as seemingly out of nowhere the bond market threw a curveball, leaving investors like me looking back at the drawing board. When I refer to “yields,” I will be specifically referring to the yield on the 10-year U.S. Treasury, which for professional investors is the most closely followed benchmark to gauge overall sentiment in the bond market.
If the financial markets were a family party, the stock market would be the rambunctious teenagers, and occasionally toddlers, making messes in the game room downstairs. The bond market would be the adults quietly reading the paper and watching the news upstairs. From the perspective of the crazies in the basement, everyone is happiest when the adults are settled, but when Dad walks over to the top of the stairs it’s time to take pause, and over the last week or so the sound of Dad’s footsteps has been unmistakable. It's time to pay attention.
The form of these footsteps is an absolutely precipitous drop in yields from roughly 1.6% in mid-June to an alarmingly low 1.28% as I write this column (source: Bloomberg). To analogize this in stock market terms, its roughly the equivalent move of about 4,000 points down on the Dow Jones Industrial Average in only two weeks, which we can all agree would have gotten everyone’s attention. The question that now must be asked is, what does this mean?
Yields go up when markets expect economic growth to ensue or continue. On the flip side, yields go down when markets anticipate diminishing growth or even recession. With the job market roaring back, supply chains healing and consumers emerging from their COVID dens with money to spend, the obvious expectation was growth. So much for the obvious; let’s look at some potential culprits.
As usual, at the top of our list for potentially screwing things up in Washington. Political bias aside, as an endeavoring policy observer I can only describe the economic policy rhetoric coming out of Washington right now as, well, just bad. Huge confusing multi-trillion-dollar spending initiatives, running around the world trying to generate excitement for a global corporate minimum tax, failing anti-trust actions on big tech. It's all just kind of a mess, but fortunately, it’s also kind of an ineffective mess. Investors know every day we get closer to August is a day we get closer to the Congressional recess, which means we also get closer to the campaign season for the mid-terms when theoretically some logic should prevail. So, beyond the words coming out of Washington, the actual action is comparably sane and likely not enough, in my opinion, for the bond market to ramp up the recession trade.
The second culprit could be COVID. With the new delta variant getting throngs of daily media attention, the bond market could be hedging new rounds of lockdowns. There are, however, so many moving parts to this equation I have a hard time believing the professional investors operating in the bond markets would be willing to position real capital on this very unforeseen and likely remote possibility.
A third option could be this is a technical “head fake.” When so much consensus coalesces around one narrative, such as interest rates going up, the trade can get “crowded,” creating an opportunity for professional speculators to bet against the consensus view. A review of a long-term chart (source: Bloomberg) of historical moves higher in yields indicates these moves are often proceeded by a set up trade of yields moving the opposite direction. Only a little more time will tell if this trend is being repeated.
Candidly, this trend has caught me by surprise and at this point, more time is needed to formulate conclusions, but we will need to revisit in a few weeks.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
