Whether one likes it or not, Treasury yields hitting 3%, which they look bound to do, will be a major event. The big question is what to do once it happens. Is it the signal of a sharp move higher in yields, or will it be the climax to a short-lived selloff? The reality is that if Treasuries move just a little above three, there could be a strong wave of selling. However, strategies betting against volatility have been paired back in recent weeks, so the selling might not be as furious as one might fear.

FINSUM: Nobody has any idea what will happen if Treasuries move above 3%. As far as bonds, we expect that there will be more and more organic buyers above 3%, which should keep things in check. On the stock side, we do not see why a move higher would be too bad, as the spread to equity yields will still be wide.

(New York)

Here is a tough question to judge—are Treasury bonds yielding 3% good news or bad for the markets? Investors themselves haven’t made up their minds. At first the prospect of rising yields spooked investors, but they have recently grown much more tolerant. While at first investors were shy about rising rates ending the recovery, higher yields now seem to be interpreted as a sign that we have finally overcome worries about “secular stagnation” in the economy.

FINSUM: Our own view is that rates rising back to “normal” is a sign of the economy doing well, and thus is nothing to fear for equity investors.

(New York)

The market did something that seems quite odd yesterday. Despite inflation coming out ahead of expectations and Treasury bonds commensurately selling off, stocks rose strongly. It was the first time the two asset classes had moved in significantly opposite directions in some time. Yields on the ten-year bond extended their four-year high to 2.92%, seven basis points higher than in the previous session.

FINSUM: We have been saying for the last couple of weeks that investors would realize inflation wasn’t necessarily bad for stocks. The market seems to have woken up to that reality.

(New York)

Goldman Sachs put out a big warning to the market yesterday. The bank’s fixed income division says that it thinks yields on ten-year Treasuries are going to rise to 3.5% within two quarters as the Fed continues to hikes rates and the market sells off. Goldman called its prediction “not very brave”, indicating it thinks yields might be higher, especially since it feels the Fed will hike four times this year. Goldman’s forecast for rates is much higher than most analysts, so if it comes to pass, it could have big ramifications for equity investors.

FINSUM: If yields rose to 3.5% or above that quickly, we expect the equity markets would perform very poorly, and it may be the kind of scenario where we have a recession.

(New York)

So far all the attention of the selloff has been confined to two major areas: Treasury bonds, and to a greater extent, equity markets. Treasuries have stabilized a bit given all the turmoil in equities, but one of the areas investor need to watch carefully is junk bonds. The more equity-like bonds have been holding up well, but finally started to crack this week as outflows have been strong and the main junk bond ETF had its worst day in a year. The spread to Treasuries is still historically low—346 basis points—which means that there is a lot of room for a correction, though Bloomberg says this is giving fund managers some comfort.

FINSUM: If equities keep falling it seems like junk will fall some. However, the protection of yield, and the fact that earnings and credit worthiness are good should be supportive.

(New York)

One of the guiding ideologies of the bond market over the last few years has been to buy the dips. Every time that bond yields have risen some, it has been smart to go long bonds as they inevitably came back down. However, this time looks very different. The difference is that central banks are no longer fixed to their ultra-low rates policy, which means there is no big magnet that pulls rates and yields ever downward.

FINSUM: So in our view what is really happening right now is a market wide price discovery period for bonds. Because the underlying situation is changing, no one is comfortable judging bond yields and prices. This worry has spread to equities, but in our view the root anxiety is in fixed income.

(New York)

Any financial advisor will tell you that most of their clients love muni bonds. The asset class has been very popular for many years among the wealthy because of the bonds’ tax exempt status. Therefore, advisors need to pay attention, as there is a little discussed, but very real ticking time bomb in the asset class. That big time bomb is unfunded pension liabilities. The projections made fifteen years ago may have been plausible, but with a financial crisis and then years of rock bottom rates, many think state and local pensions have reached a point of no return which will lead to major defaults. Barclays’ munis team recently noted “We are increasingly wary of high pension exposure, especially among state and local credits”, continuing that “short-term investment gains won’t be sufficient to plug liability gaps”.

FINSUM: There is bound to be a big wave of defaults in the muni space. This is a big and slow-moving crisis that nobody, especially the federal government, wants to deal with.

(New York)

Well it finally happened yesterday. The big selloff in bonds finally managed to legitimately spook the equity market. Stocks in the US were down big as the yield on ten-years jumped mightily. The ten-year yield is now 2.73%, the highest in three years, which was a significant mental threshold. Investors are worried that with the world economy doing so well, inflation may again rear its head, causing central banks to raise rates quickly. The S&P 500 fell 0.7% on Monday.

FINSUM: Okay here is the big question we have—why would the world economy doing well and higher rates be negative for stocks? If anything, equities are a good inflation hedge.

(New York)

A lot of analysts and market gurus are currently talking down the high yield sector. Credit spreads have been rising and it does look like we are headed into a higher rate environment, so the arguments seem reasonable. However, Barron’s says there is still time to get in on high yields. One of the best parts of the market right now is that only 10% of it is comprised of CCC rated bonds, way below its average of 15-20%. That means credit-worthiness is better. Additionally, junk firms have been refinancing for years at ultra-low rates, which will keep default rates pinned. Finally, oil and gas firms, which comprise a high share of the market, are in better shape as prices have been recovering.

FINSUM: There are definitely some strong points here, but it would be a highly contrarian view to say that the prospects for the sector look good after surging for so many years. At best, the fundamentals look solid, but the macro environment looks poor.

(New York)

There has been A LOT of talk lately about a bond bear market. The idea is that rates are now in a secular rising cycle led by a hawkish Fed and rising inflation. The issue with that view is two-fold. Firstly, the bond market “experts” calling for the bear market are well-served if it comes true because of the strategies they use. And secondly, there isn’t really evidence of much inflation and the Fed is not looking overly hawkish. The one really worrying thing is that the economy has been performing well, which does lend itself to rising rates and more money flowing into risk assets.

FINSUM: We think all these worries are premature. We have a new Fed chief coming in which now one is sure about, and there just isn’t much inflation. Plus, there are tens of millions of people retiring who will need income investments.

Page 44 of 45

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