Investors are currently worried about corporate bonds. On the one hand performance has been pretty good, especially for the riskiest bonds. But therein lays the problem—highly indebted companies have not been punished and there appears to be way too much corporate debt at the moment. This is the Fed’s view and many market participants, but Goldman has shared another—that the amount of corporate debt in the economy is just fine and corporate balance sheets look healthy. The bank says US companies are in an “unusually healthy position this deep into a business cycle expansion”. Goldman notes that companies are spending a smaller share share of their cash flow on interest than they were a decade ago, and that they are earning more than they are spending.
FINSUM: The corporate debt situation is all about perspective. Things look better than in the last crisis, but anyway you slice it, the debt burden looks at least somewhat daunting.
One of the most famous names in bonds, Jeffrey Gundlach, has just put out a bold statement. Gundlach thinks there is forthcoming trouble in markets and he thinks it is the Fed’s fault. Specifically, Gundlach thinks the bond market is set for a lot of volatility. “interest rates cannot maintain the low volatility they have maintained over the last eight years”. To be clear, Gundlach is not calling for a recession, but says “But I am starting to think it is much less of a lock that there won’t be a recession before the next recession”.
FINSUM: There are two conflicting ideologies here. The Fed thinks volatility is largely an extension of the economy and policy, both of which it feels it can control to an extent. Gundlach and many other investors think there are underlying forces in the economy and markets that can only be pacified for so long. We think they are both right to an extent.
Investors, take a deep breath, everything about the rate outlook has changed in the last 36 hours. For the first quarter of this year, investors thought we were on an inevitable course for rate cuts as the Fed appeared highly dovish. Then the last two days happened. First, Fed chief Powell delivered a much more hawkish speech than expected, saying that the factors that were holding inflation down were just “transitory”. Then, jobs data this morning blew everyone away with 263,000 jobs created in April.
FINSUM: We think these two factors are a big deal. It is very far from clear the Fed is going to cut (we think the risks are now skewed toward a hike). What makes this worrying is that a lot of the rally this year has been predicated on a dovish Fed.
Something very odd is going on in the minds of investors. Data on the economy continues to come out very strongly, with Q1 growth at 3.2%, and the market are nothing short of astonishing, up 25% since its December low. But at the same time, many investors and analysts think the Fed will cut rates. The reason why is disinflation, or the fact that the inflation number refuses to rise to the Fed’s target. Looking more broadly, you also have weakening in China and a slowdown in Europe, so there are macro headwinds that could wound the US. Analysts tend to fall in one camp or the other on hikes, with some, like Scott Minerd of Guggenheim, calling the idea “plainly wrong”.
FINSUM: It is very hard to predict what the Fed will do because their u-turn earlier this year caught everyone by surprise. Our bet is that if the current data holds steady, there won’t be any hikes.
Stocks are once again nearing all-time highs, which is understandably making investors nervous about a repeat of the fourth quarter occurring. While that fear is healthy, the reality is that the underlying conditions of the market are a world different now. Not only are valuations lower, but the economy is looking robust, and perhaps most importantly of all, the Fed has let off the gas pedal with hikes, which puts recession risk much lower. All of these factors seem to conspire to make a perfect environment for stock price appreciation.
FINSUM: Anyone who reads FINSUM knows we lean towards bearish news, but the truth is that our better judgment is telling us that now is probably a time to be optimistic, as the trifecta of reasonable valuations, a solid/strong economy, and a dovish Fed, are in place.