Summary
- The disconnect between equities and yields is nothing new.
- However, this is probably the most extreme the two have ever been.
- Somehow, bonds seem to stand alone against the wave of reflation repricing which is likely the driver of commodity and emerging market strengths.
“A painting that doesn’t shock isn’t worth painting.” – Marcel Duchamp
I highly recommend checking out Charlie Bilello’s excellent 2017 Year in Charts blog post. Whether you’re a financial advisor or individual investor, Charlie puts a lot of things in perspective, and hopefully sheds light on the fallacy of following the narrative of the moment.
A quick review of where we are in markets here. All three major US stock indices (SPY) (QQQQ) (IWM) at all time highs. Emerging Markets at all time highs. Inflation expectations (TIP) trending higher. Crude Oil at 3 year highs. The US Dollar (UUP) at 3 year lows. Utilities (XLU) meaningfully underperforming in recent weeks. And despite all this, the yield curve is at its flattest level of the expansion. As Charlie Bilello (Twitter: @charliebilello) noted last week, the spread on January 4th between 10 year and 2 year yields stands at a mere 50 basis points.
The disconnect between equities and yields is nothing new. However, this is probably the most extreme the two have ever been. Yes short rates have been rising because of the Fed tightening, but the long end simply isn’t selling off in a way one would expect in a reflationary environment (at least not yet). Somehow, bonds seem to stand alone against the wave of reflation repricing which is likely the driver of commodity and emerging market strengths.
I do wonder where the most complacent trade is. Are stock investors overly optimistic about reflation? Are bond investors overly optimistic about disinflation. In the short-term, the weight of the evidence seems to favor that bonds be repriced, and longer duration income vehicles underperform. Steepening in the yield curve historically tends to be a good thing (so long as it’s gradual) because it suggests growth and inflation expectations are increasing. If indeed complacency is as high as I suspect it is in income producing assets, then it wouldn’t be surprising to see a sudden spike in long rates at some point this year, ultimately giving the Fed more room to raise rates further.
I highly recommend checking out Charlie Bilello’s excellent 2017 Year in Charts blog post. Whether you’re a financial advisor or individual investor, Charlie puts a lot of things in perspective, and hopefully sheds light on the fallacy of following the narrative of the moment.
A quick review of where we are in markets here. All three major US stock indices (SPY) (QQQQ) (IWM) at all time highs. Emerging Markets at all time highs. Inflation expectations (TIP) trending higher. Crude Oil at 3 year highs. The US Dollar (UUP) at 3 year lows. Utilities (XLU) meaningfully underperforming in recent weeks. And despite all this, the yield curve is at its flattest level of the expansion. As Charlie Bilello (Twitter: @charliebilello) noted last week, the spread on January 4th between 10 year and 2 year yields stands at a mere 50 basis points.
The disconnect between equities and yields is nothing new. However, this is probably the most extreme the two have ever been. Yes short rates have been rising because of the Fed tightening, but the long end simply isn’t selling off in a way one would expect in a reflationary environment (at least not yet). Somehow, bonds seem to stand alone against the wave of reflation repricing which is likely the driver of commodity and emerging market strengths.
I do wonder where the most complacent trade is. Are stock investors overly optimistic about reflation? Are bond investors overly optimistic about disinflation. In the short-term, the weight of the evidence seems to favor that bonds be repriced, and longer duration income vehicles underperform. Steepening in the yield curve historically tends to be a good thing (so long as it’s gradual) because it suggests growth and inflation expectations are increasing. If indeed complacency is as high as I suspect it is in income producing assets, then it wouldn’t be surprising to see a sudden spike in long rates at some point this year, ultimately giving the Fed more room to raise rates further.
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