(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.
(New York)
Stock investors may be in for some big upside surprises while bond investors’ hearts may sink. The new tax regime may have a major unintended consequence for bond markets. With the new lower corporate tax rate, many multinationals are likely to repatriate hundreds of billions of Dollars. For the last several years, much of that money has been parked in Treasuries and other bonds. But with the ability and likelihood of reshoring, companies are likely to pull huge amounts of capital out of bonds and put it into stock buybacks and dividends. This could be a big plus for equities, but bond markets could sink as massive amounts of capital are withdrawn.
FINSUM: This is the first convincing argument we have heard for why any fundamental force, outside of the Fed, could bring about a bond bear market.
(New York)
The media and many bond market gurus would have you think the ceiling is caving in on bonds. Talk of a massive bear market, surging inflation, and big losses abound. How to make sense of it all? The answer, if there is one, is that reversals in rate environments tend to take a long time, and have historically lasted 2-3 decades before reversing back. Therefore, bond yields may continue to climb steadily, but this shouldn’t be bad for the stock market, so big losses may be avoided. In fact, slowly rising rates can spark structural bull markets. It would also be helpful for pension funds to have higher yields as they could be safe in assuming better returns, helping fund the huge national pension deficit.
FINSUM: We just are not that worried about bonds. The Fed still seems fairly timid, there is high natural demand for yields because of demographics, and inflation and growth aren’t all that strong.
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(New York)
The big bond gurus of Wall Street, Bill Gross and Jeffrey Gundlach, both struck fear in the hearts of bond investors yesterday, saying that the recent Treasury sell-off confirmed that a bond bear market had begun. However, Morgan Stanley is now pushing back against that assertion, saying that Treasuries are still offering value and should be fine. “This isn’t the bear market you’re looking for” says Morgan Stanley. MS says that the Fed is not likely to react sharply to inflation and that the Chinese aren’t going to stop buying Treasuries outright, both factors which will support the market.
FINSUM: While there are some headwinds related to possible tightening, on the whole there are a number of fundamentals which seem likely to continue to support both Treasuries and credit (like demographics—we know we often mention this point).
(New York)
Bond gurus across Wall Street were calling it the beginning of the bond bear market. Treasuries had dropped significantly, with yields holding over 2.5%. However, the selloff halted yesterday as reports of Chinese plans to stop buying Treasuries were reported as possibly false. A commentator from BNY Mellon explains the situation best, saying “Whether the news of Chinese withdrawal was fake or not, the Treasury market is likely to continue to feel a little fragile, but the fact remains that the hunt for yield goes on and with no real signs of inflation yet and improving growth, there are still no real sellers out there”.
FINSUM: We think that is a very eloquent summary of the current situation. We do not think it is time to be bearish yet.
(New York)
Some of the biggest names in bonds are making a bold proclamation that all investors need to hear—that the 30-year bond bull market is over. Both Bill Gross and Jeffrey Gundlach are saying that with Treasury yields rising—currently sitting about 2.5% on ten-years—the bond market has entered a new phase. Gundlach says we are entering an era of “quantitative tightening”, which will cause losses for bonds. Gross says the bear market was confirmed when 5y and 10y Treasuries crossed 25y trend lines recently.
FINSUM: We may very well be entering an era of tightening, but that does not mean it will necessary be a brutal bear market, especially with the demographically-driven demand for bonds. Additionally, with the economy going very well, a recession could be coming, which would ease the tightening.
(New York)
With stocks riding so high and anxiety building about a potential downturn, espousing and building a robust bond strategy is going to be more important than ever. With that in mind Barron’s has put out four bond funds picks for 2018. The picks are the Vanguard Tax-Exempt Bond Index, the Artisan High Income fund, the Prudential Short Duration Muni High Income, and the Dodge & Cox Global Bond.
FINSUM: The Vanguard fund really caught our eye. It has an expense ratio of 0.19% versus an average of 0.8% for its peers, and has more than $190 bn under management, with a lot of expertise managing it.