Bond market cobra
:: Bear market continued
Bond markets have woken from their summer slumber. Interest rates have spiked sharply higher at nearly all maturities and in most geographies. Stock markets and risk assets have reacted with clear discomfort. Safe haven sectors, with little cyclical skin in the game such as utilities have fared relatively well, while past winners, particularly technology stocks, have shed several layers of profits in a short space of time.
With bond yields continuing to sway hypnotically before us, seemingly poised to strike a killer blow to the economic cycle, we wonder whether the bond market is trying to tell us something different to the wider market's current downbeat interpretation.
As the world economy has slowly but surely proved itself to be less structurally impaired than routinely feared, yields have risen. However, the rise in yields has not been smooth and steady. As a result, the correction in bond yields has come in lurches. There was a dramatic move between September of last year and January of this year, as the prospects for inflation warmed a little. We've seen another lurch higher after a summer of jarring Brexit, trade and emerging market headlines had perhaps burnished the fixed income complex's safe haven appeal a little.
Interestingly enough, many of the same market commentators who worried that an imminent yield curve inversion was the thing to keep us up at night and out of stocks are now telling us that we should take the same message from the current spread widening. Sharply higher interest rates can of course inflict a bout of indigestion on both the economy and capital markets. Some of the popularity of sectors such as technology rests on the low interest rate environment that has characterised much of this economic cycle. Meanwhile, the wider valuation beauty parade is very much anchored by the so called risk free rate, often proxied by the yield on US Treasuries (there is no such thing as risk free). As this yield rises, so does the hurdle that equity markets have to hop over in order to be relatively attractive.
However, in spite of this sharp move higher in long end borrowing costs, we are still not close to the point which starts to materially bite into the relative appeal of stocks.
In a world economy as intricately intertwined as the one we continue to live in, in spite of some policy makers' best efforts, it remains hard for an economy the scale and importance of the US to grow in isolation for long, without that warmth being felt elsewhere. This US administration may be talking protectionist, however by pumping a large quantity of fiscal steroids into an economy that is already using most of its resources, its walk is somewhat different in character. Rising imports and a trade deficit pay testament to the idea that the US's fiscal surge will not be hogged by the US alone.
To this end, the divergence in the US and emerging market stocks seen so far this year looks overdone. If, as we suspect, the bond market is telling us that the next recession is further away than might have previously been thought, we feel it is important to use that time wisely in our tactical allocation.
:: Claire McCombe is a private banker with Barclays Wealth & Investments NI