We might have just reached an inflection point in the market-economy mechanism. For the first time since 2008, short-term Treasury yields have just reached the same level as equity dividend yields. It is not even the two-year Treasury we are talking about, but rather the three-month, whose yield is now about 1.9%, the same as equities’. The convergence of a number of different yield rates is a strong warning sign of a pending recession. JP Morgan comments that “What has been surprising this year has been the degree to which cross-asset performance has behaved as if the late cycle had already arrived, despite little material change in the growth outlook”.
FINSUM: This is an important indicator. Both bond and stock investors are moving ahead of the economy itself, but their actions seem likely to create the reality they fear.
Investors beware, the market might be losing its nerve. Back and forth markets for most of this year appear to be making investors very wary, as the market is fleeing to cash. Investor holdings in “cash sanctuaries”, which include money market funds, are approaching 2%, the highest level seen in a decade. According to one prominent asset manager “Cash is an asset class once again”. According to Crane’s, “Money funds were on a starvation diet with yields at zero percent … Rate increases have given them a stay of execution”.
FINSUM: Aside from volatility, the other big driver is that yields on money market funds have risen considerable alongside the Fed hikes, making them much more attractive.
JP Morgan has just put out a guide which may be very interesting to investors—a manual for how to navigate the end of easy money. The bank thinks the equity market’s response to earnings has been very worrisome lately, and they are very bearish. The bank recommends that in 2019, investors go underweight equities and long gold and long duration as the economic cycle ends and real rates “collapse”.
FINSUM: This is an extraordinarily bearish outlook from JP Morgan, and it seems mostly dictated by weakness in equity prices lately. Investors should take this warning seriously.
Yields on the ten-year Treasury note crossed the 3% threshold this week and seem set to stay there for some time, sparking a big change in bond markets. Bloomberg argues that yields at this level change everything for all asset classes. The reason why is that a jump in yields to above 3% starts to cause a shake out amongst highly indebted companies, boosts the Dollar, and in turn, makes emerging markets less attractive.
FINSUM: To be honest, our biggest concern was not even discussed by Bloomberg, which is how higher yields affect the arithmetic for whether to put money in richly valued stocks, or into bonds that are starting to offer acceptable returns. 3%+ yields really could put an end to this bull market.
On Tuesday markets seemed to reverse course. Even as stocks plunged, it appeared that for the first time in recent memory, they were the asset class driving bonds rather than the other way around. Yesterday, the idea of equities taking on a life of their own seemed to reinforce itself, as stock rose modestly even as bond yields jumped higher and stayed steady above 3%.
FINSUM: This is a very tenuous time for markets. Something is definitely happening in bonds, but no one—Wall Street included—knows exactly what.
The ten-year Treasury rose to just above 3% for the first time in years yesterday, possibly signaling the start of a new era for fixed income. Therefore, one would be forgiven for thinking the bond market drove the big losses in stocks yesterday. However, the opposite may be true, as for the first time in a while, it seems that worries over earnings and new measures of investor sentiment sent the market sharply downward. In a total reversal from January, investors are now very bearish on the market according to economic surveys. This news appeared to spook investors and then in turn disturb the bond market.
FINSUM: Yesterday might be the start of a poor cycle, where stocks and bonds take turns scaring one another to steeper losses. Perhaps that is just a manifestation of a changing cycle.