One of the world’s most respected financial columnists—John Authers—has just put out an article arguing that we may be at the bond market’s Dotcom moment. Authers cites the gigantic hoard of negative yielding debt, as well as many charts of soaring 100-year bond prices (check out Austria’s and Mexico’s), to show that the bond melt up may be set to reverse. He argues that at some point soon (it could have already started with the reversal in ten-years yesterday) that investors will revolt against super-low yields, sending prices lower and yields higher. Authers thinks the spark may be unexpectedly higher inflation, which would undermine the whole premise of recent gains. Tariffs are inflationary by definition, so it is not far-fetched to think this could occur.
FINSUM: We think it would take a significant catalyst to cause a big bond pullback (like a much higher than expected inflation report, a suddenly hawkish Fed etc). That is not out of the question, but it does not seem likely.
Beyond high valuations and a potentially worrying economy (not to mention a trade war), there is something else investors need to worry about. Goldman Sachs is warning investors that S&P 500 companies are engaging in unsustainable financial payouts. The bank shows that in the year ending in March, companies in the index spent about 104% of their free cash flow on buybacks and dividends. It is the first time since before the Crisis that companies spent more on payouts than they generated in free cash flow.
FINSUM: So far this behavior is not hurting companies because investors are okay with extra leverage given the likelihood of Fed easing, but this is definitely a warning sign of financial excess.
Want to know one of the biggest risks in equity markets right now—parity, and we don’t mean between asset classes, we mean between investors’ portfolios. Momentum buying, or buying up stocks that have performed the best, has become such a hot strategy this year that both mutual fund holdings and hedge fund holdings look very similar. Everyone has the same basket of stocks, such as Mastercard, Paypal, Amazon, and Microsoft.
FINSUM: Since value investing has all but died—no one is interested in undervalued stocks—portfolio parity is increasing. This seems like a big risk that will magnify a reversal.
The bearish stream of warnings from Morgan Stanley continues unabated. The bank’s wealth management CIO has just made another big call for the firm, saying a correction is likely. Lisa Shallett of MS Wealth management says that the Fed is trying to fight the end of the cycle, and it will likely prove too hard to do. She believes that a recession and correction are highly likely in the next year and that stocks will drop by at least 10%. That said, she advises investors to buy further intro underperforming sectors.
FINSUM: Morgan Stanley says explicitly that they think the bond market’s call on the economy is more correct than stocks and that an economic hard landing is likely coming.
Don’t let the cooling of the trade war between the US and China fool you, the markets are not in a good position, at least that is the position of Bank of America. The bank thinks there won’t be a deal between Washington and Beijing until the US market feels real pain. They think the looming Q3 correction will be the stimulus that gets a deal done because Trump operates under a “no pain, no deal” paradigm. “The markets are likely to view the summit as a modest positive in the short run. But stepping back, we see several reasons for concern”, says Bank of America.
FINSUM: The “no pain, no deal” concept makes a lot of sense to us. The bigger question, though, is what would cause the pain because markets certainly aren’t hurting from the threat of a trade war. Maybe a big earnings miss? (See below)