Recently, the financial headlines have mostly been about U.S. stocks and their post-election assault on all-time highs. Much of the discussion, however, has been about the other side of the U.S. coin: bonds, and their coinciding sell-off (and thus a steep rise in rates). It's funny that after such an extended period of exceptional behavior between stocks and bonds in which they often moved up and down together, it seems almost odd that this recent decoupling seems dramatic. Of course, their correlation was only exceptional in that it was an exception, and not the rule.
But let's not get too excited just yet, as the recent rise in yields is, in the big picture, a mere blip on the radar screen. Indeed, look at the 30-year; rates are still near all-time lows, and the current spike is no greater and got us no higher than the last two occasions.
So while not getting ahead of ourselves, we should at least take note of and not be surprised by the opposite behavior of the stock and bond markets in the United States. In our pre-election note, we discussed the significant outflows from U.S. equity mutual funds and ETFs, in part into bonds, but primarily into cash and cash equivalents. It was my contention that investors were determined not to be caught off guard, and though the world feigned shock on the morning of November 9, the real shock to the world was that, unlike with Brexit, the markets were prepared.
And now that we have a president elect who is talking of fiscal stimulus and corporate tax cuts, is it a wonder that we are now seeing huge flows back into equity markets, causing said markets to surge? And again, should we be surprised that investors are leaving the safe haven of bonds (at near all-time low rates) in search of greater return? Or isn't that what is supposed to happen?
The November 21 issue of Barron's discussed bonds at length, with both the Up & Down Wall St. and Streetwise columns discussing the massive reversal in flows and how the outsized moves may be overdone. The case was simply that the fundamentals did not support the size and scope of the current move, and that they should reverse. The Barron's cover story, however, suggested that this short-term move may be the beginning of a long term trend, and that America would be wise to lock in current rates for the long-term (fifty to one-hundred years). On the surface, these may seem like conflicting market calls, but really they only differ in duration. Short-term, it is very difficult to know if the recent move in rates should be bought or faded, and to us, any sudden, dramatic move is often a sign of overreaction, and generally corrects itself over some time. And if that is what the "fundamentals" suggest, then all the better. But on a much larger scale, the probabilities suggest we are far closer to a bottom in rates than a top, and the long -term risk is that they will rise. I say this because when I look at the "fundamentals", not of the U.S. economy nor its so-called proxy in equity markets, but in the market fundamentals of supply and demand, I see massive demand for investment return, and very little supply. The world's asset classes have become commoditized, and the long term trends are supported by where the money is going.
There has never been a period of time, in the history of the world, when money had been this abundant and this cheap. And it all needs to go somewhere. The U.S., for all its problems, has been one of the only plausible options for professional investors over the past seven years; the cleanest dirty shirt so to speak. And all that cheap, abundant money has kept accumulating in US markets, boosting both stocks and bonds for years. It is no wonder that stocks and bonds rose together, despite tepid economic growth and constant FED chatter, because investors needed to buy both.
And now, after an election that at least provided some clarity, and plenty of pro-growth rhetoric, stocks are doing what they should do when people buy them en-masse, and bonds are doing what they should do when people sell them. As Josh Brown of Reformed Broker fame wrote on his website: Our new president also has both houses of congress on his side for the first time since the beginning of W’s administration. Talk of massive fiscal stimulus and tax cuts is in the air and bonds are selling off, providing the fuel that stocks needed to break away. Stock funds have seen $130 billion pulled from them over the last year and most of that money went into bonds. If there is truly a sentiment sea change at hand – with investors in the mood to allocate to risk – it could go on for awhile.
Up until the election, the best case one could make for the continuation of the equity bull market was not citing company specific nor economic fundamentals, but rather citing the massive amounts of money throughout the world sitting in safe havens: bonds, certain commodities, and cash... and that this money would eventual need to chase performance and "rotate" into equities. But for years it was a waiting game, with investors looking for the impetus to pull the trigger and the Fed really being the only entity that could provide it. The Fed was the only game in town... until now.
Honestly, there are just too many variables to know for sure what will happen going forward. But I do know there is an unprecedented amount of invest-able money in the world, dry powder so to speak. And if a meaningful amount of that continues to rotate into U.S. equities, instead of simply waiting around and buoying both equity and bonds, then we very well may see unprecedented levels in the U.S. stock market continue for quite some time.