The 127th episode of my weekly YouTube show where I discuss what is happening in investment markets and what to look out for. This week I talk about the bond market and how it is impacting markets. Is it trying to tell us something?
Each show lasts between 5-10 minutes and is aimed at DIY investors (including novices) seeking contemporary analysis to help them understand how investment markets work.
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Abridged transcript - Midweek Markets episode 127
In last week’s show, I spoke about how the market had become concerned that the ECB, the US Federal Reserve and the Bank of England (BOE) would make policy mistakes by tightening monetary policy too soon, in fear of rising inflation but ultimately snuffing out the post-pandemic economic recovery. But ultimately the markets were caught wrong footed, with their hawkish predictions being met with more dovish announcements from the three key central banks.
The focus then shifted to each central bank’s credibility in managing the balancing act of inflation and economic growth but also their ability to communicate their intentions.
For equity markets the central bank decisions had been the catalyst to push them higher. But the other catalyst was the House of Representatives passing President Joe Bdien’s $1 trillion infrastructure bill over the weekend. Unsurprisingly, at the start of the week, investors began piling into infrastructure stocks.
On Monday, in the US, we therefore saw the 8th all-time high close on the S&P 500 in a row, making 65 so far for the year, surpassing 2017 (62) and only just behind 1995 (77). The S&P 500 also closed above 4700 for the first time. The economically sensitive Dow Jones also hit another new all-time high on Monday. Ahead of the weekend we also saw the 44th all time closing high for the Nasdaq.
Over in the UK the FTSE 100 was less buoyant than its US counterparts, falling back below 7300, largely due to weakness in the financial sector after the BOE performed a head-fake on a rate hike and surprised the market by leaving its base rate unchanged. While in Europe we saw new records for the German DAX and the French CAC40.
But what is notable is the shift in sentiment from one of fear of collapse to one of fear of missing out. No clearer can this be seen than in the US with the CNN Fear and Greed index which shows that the emotion driving the market has gone from fear to extreme greed in less than a month. In fact the last time we saw such an aggressive move was in the aftermath of the US election and the first COVID-19 vaccine in November 2020. While the reliability of this index as an indicator is perhaps a topic for another day, but if you love an investment quote then the famous one from billionaire investor Warren Buffet “be fearful when others are greedy, and greedy when others are fearful” springs to mind.
Indeed by Tuesday this week we had started to see some tentative signs of profit taking in the US, albeit moderate. The outlier was Tesla. By Tuesday the stock price had slumped almost 15% since the weekend after Elon Musk ran a twitter poll asking followers whether he should sell a 10% stake in Tesla, More than 3.5 million people voted in the poll, with around 58% voting for share sale. Elon Musk claimed he would honour the poll outcome, which would mean he would dispose of around £16bn of Tesla shares.
The possibility of such a large share sale spooked investors, with Tesla's share price tumbling on the news. But cynics claim it is nothing more than a stunt by Musk, in response to a billionaires tax, proposed by the US Democrats which would force billionaires to pay tax on unrealised stock gains. So some cynics claim Musk was already thinking about raising cash for a potential tax bill anyway. In any event the fall in the price of Tesla began proving a drag on the S&P 500 and the Nasdaq 100.
Coincidentally the US Federal Reserve published its financial stability report around the same time, and raised concerns about a festering debt crisis in China’s property sector as well as concerns over risky assets’ prices continuing to rise, “making them more susceptible to perilous crashes if the economy takes a turn for the worse". Furthermore, “asset prices remain vulnerable to significant declines should investor risk sentiment deteriorate, progress on containing the virus disappoint, or the economic recovery stall."
New all-time highs in stock markets are bullish patterns but it is perhaps these concerns raised by the US central banks, alongside the growing fear of a policy mistake by one or more central banks that are fuelling a trend that appears to be gathering pace in the bond market. If you recall last week I spoke about how the central bank policy decisions pulled the rug from under bond markets, especially in the UK, where gilt yields fell back below a yield of 1%, while the 10 years US treasury yield fell back to 1.56%, having risen as high as 1.67% two weeks prior.
Fast Forward to yesterday and we saw bond prices rally strongly, meaning bond yields slumped. The 10 year UK gilt yield fell to 0.82% while the 10 year US treasury yield hit 1.43%, levels not seen since late September.
With so many investors betting against bonds, the rally has caught a number of institutions off-guard and brought about a spot of short covering. This is essentially where investors reverse their bets that bond yields will keep rising, by ultimately having to buy bonds to do so, so pushing up the price of bonds.
While this could be nothing more than a blip but if you look at a chart of the 10 year US treasury yield for example, there has been a definite downtrend in bond yields since 21st September, and unless there is an about turn soon, then technical analysts will be pointing to a recent double top in bond yields. That would change the dynamic of the market and possibly usher in a period of equity market weakness.
For now, equity markets are proving resilient but it's worth keeping an eye on what is going on in bond markets, if nothing else it we could see another rotation from the reflation trade to the stagflation trade assets. 80-20 Investor members can refer back to my research on the funds that could benefit from such a move.
Right now, global bond fund investors will be happy, as most of these funds have significant exposure to US bonds, so they’ve also benefited from the crash in the pound over the last week. Right now the pound sits at $1.356 but has been as low as $1.343. Keep an eye on the September low of 1.3411 because if that falls then we could be heading down towards $1.31. If this does happen it could provide a buffer for wobbles in bond/equity markets in the coming days and weeks.