Like a cross between 'Deliverance' and 'The Shining'
The bond market used to be dull...
Filled with fall colors, it was unusually warm and sunny in upstate New York, where I spoke at a tucked away ski resort. We met no cars driving up the mountain, and the lodge was silent. The restaurant there was closed “because it’s Wednesday,” so my colleague and I found a nearby bar and grille on the second floor of an empty warehouse. It was a bit eerie, much like what seems to be happening in the financial markets. In a matter of weeks, bond yields have climbed to near two-decade highs, with another big move this morning on an unexpectedly strong September jobs report (more below). Evercore ISI doesn’t think the bond market is adjusting to a new and higher neutral rate (where there’s balance between supporting the economy and keeping inflation constant) as much as it’s following a line of least resistance amid upward pressures on all components of yields, particularly term premia. Investors are looking at a future of higher-forever issuance and an exodus of usual buyers from the Fed to foreign customers and insisting on higher yield/return compensation to offset those risks. Since its July 31, 2020 high, a popular 20+ year Treasury ETF has fallen the equivalent of the 57% drop in the S&P 500 during the 2007-09 crisis. (Do you hear those “Deliverance” dueling banjos?)
Now, for some good news about the bond market—it will be closed Monday for Columbus Day! But bond vigilantes will be back to business first thing Tuesday. After decades in the shadows, they’ve been out in full force, upset with massive deficits as far as the eye can see. After 25 years of unfettered fiscal spending, the U.S. in July hit the critical threshold for debt servicing costs of 14% of tax revenues. Since then, Fitch downgraded the U.S. credit rating; Treasury needed an additional and unexpected $250 billion of debt issuance in Q3, so large it had to increase coupons for the first time in more than three years to lure buyers; and Republicans removed the Speaker of the House for not cutting spending enough (among other reasons). A century of fiscal debt data shows that once that net interest cost goes above 14%, the U.S. moves into a prolonged period of austerity. An expected end to decades of fiscal partying comes as the market also is repricing an end to the easy money era that began 15 years ago this week, when Congress passed the TARP bailout. That kicked off a flood from monetary spigots, with G10 central bank balance sheets sextupling from $5 trillion to $30 trillion by’21. Yardeni Group believes rates now are simply normalizing, i.e., resetting to where they were before this “new abnormal.”
All the major equity indexes were in the red in Q3, as were most S&P sectors. The equally weighted S&P is back near where it was at the start of the year, and the average S&P stock is down roughly 20% from its 52-week high. But technicals reflect a market that’s oversold, with negative sentiment at extreme levels and the seasonally weakest period of the year (August-September) giving way to the strongest (October-December). S&P total returns have averaged 4.8% in Q4 and have been positive 81% of the time. What might be a catalyst? Strong Q3 earnings that kick off next week, perhaps? Operating margins bottomed in March and turned higher recently. Sales growth also has been revised higher. Boosted by stronger-than-expected growth (which got another lift with today’s jobs report), Yardeni expects S&P EPS to hit a record high in Q4 barring a long auto strike, government shutdown or surprising credit losses at banks (more below), and possibly as soon as Q3. The lodge will start hopping on Saturday with a beer festival , quickly followed by fright night on the zip lines, and ski season! The deserted ski lodge reminded me of Jack Nicholson “working” on his book—all work and no play make jack a dull boy. The bond market used to be dull …
- The labor market is resilient September nonfarm job growth more than doubled expectations, and August was revised up sharply, too. Yet average hourly earnings were flat, dropping the 12-month average increase to 4.2%, the least since June 2021. Also this week, a slight rise in initial claims kept the 4-week moving average near multi-generational lows, layoffs surprised lower and August job openings surprised higher.
- Handoff September’s manufacturing ISM and PMI surprised, led by rising output, new orders and new export orders. Headline levels are now bordering contraction/expansion and moving up. To the opposite, companion services gauges came in a little weaker than expected (though still solidly in expansion). Global PMIs reflected a similar handoff of growth from services to manufacturing.
- The cure for higher prices is higher prices After a 30% summertime spike, AAA’s average price for a gallon of unleaded gas has fallen 13 cents in two weeks. Waning demand suggests further declines lie ahead, with U.S. gasoline consumption at its lowest seasonal level in 25 years. WTI oil prices have behaved similarly; after jumping 28% in three months, they’ve plunged $11 in a week to $82 a barrel.
- Black swan in plain sight? Amid banks’ excessive reliance on “risk free” Treasuries, might the market want to revisit potential mounting losses on bank balance sheets following the recent spike in longer yields? Jefferies reminds this issue took down Silicon Valley Bank in March when the 10-year yield was 4%. It’s now flirting with 4.8% on this morning’s Treasury sell-off after the strong jobs report. The KBW Bank index is revisiting price levels of 25 years ago.
- With friends like these Higher oil prices, a stronger dollar and rising U.S. yields are creating big headaches for our friends across the pond. Taken together, the factors are creating more financial tightening and delaying a disinflationary process that had promised a benign turn in the eurozone’s economic cycle, leaving the ECB in a tight spot.
- Blowout volumes rarely mark lows (or highs) Those tend to follow later with less drama, Strategas Research says, citing 10-year Treasuries hitting 4.898% this week and 20+ year Treasury ETF volume rivaling early Covid stress. It’s not just a U.S. story. It counted 16 countries with 10s at fresh highs.
The boomer consumer reigns supreme Despite high loan rates, September auto sales beat estimates, rising to 15.7 million annualized. Real spending is back to its pre-pandemic trend, boosted by above-average labor income growth relative to other developed markets, where spending remains depressed. Among the drivers, Bank of America says, is a boom in baby boomer net worth since 1980s to $70 trillion ($60 trillion in financial assets) that is $4 trillion of cash on 5% money market yields.
Boomers feel your pain Bank of America thinks the 1980s, not the 2008 crash, better reflect the situation in housing. Leading up to 1980, y/y inflation was soaring and Fed hikes doubled mortgage rates. But baby boomers entering their prime home-buying age prevented a collapse. Today, millennials are in a similar situation, a big problem being they can’t find supply. Builders are rushing to fix that, with single-family home construction jumping 1.7% in August, the fourth straight monthly increase.
Might history repeat? Small caps’ relative underperformance vs. large-cap Tech hasn’t been this great since April 2000, at the dot-com bubble peak. Why is this significant? Wolfe Research notes small caps went on to drastically outperform Tech and Growth the subsequent two years while the market sank by half.