Providing succinct, entertaining and savvy thinking on global capital markets. Our goal is to provide discerning investors the most essential information and commentary to stay in tune with what's happening in the markets, while providing unique perspectives on essential financial issues. And just as important, Fisher Investments MarketMinder aims to help investors discern between useful information and potentially misleading hype.
In a telling sign of just how hyper-focused people are on bond markets right now, one of this week’s most-watched events was … Treasury bond auctions. Usually, the Treasury’s debt sales to its regular customer base of banks and institutional investors don’t garner much attention. Success is usually a foregone conclusion, making them more dog bites man than man bites dog for news editors. But two weeks ago, a sale of 7-year Treasurys attracted the lowest demand since 2009. (Never mind that bids totaled just over twice the amount on offer.) That supposedly bad auction triggered some fear, contributing to yields’ recent uptick, and making this week’s three auctions much-watched events. The last one happened today and—spoiler alert—it went great, which we think offers a couple of lessons for investors.
The first of this week’s festivities was an auction of 3-year notes on Tuesday, which attracted demand of 2.69 times the amount on offer at a median yield of 0.32%.[i] Wednesday’s offer was a 10-year note, which was similarly oversubscribed with a bid-to-cover ratio of 2.38 at a median yield of 1.47%.[ii] Rounding out the pack was Thursday’s sale of less-plentiful 30-year bonds, which attracted bids for 2.28 times the amount on offer an a median yield of 2.23%.[iii] All were nicely above the 2.04 bid-to-cover ratio at that supposedly disastrous 7-year auction two weeks ago.[iv] They were also right in line with their trends over the past eight months since yields bottomed last August. That suggests to us that the panic-inducing auction was an aberration and investors are very, very happy to buy US bonds.
The surface-level takeaway here is that Congress’s multiple debt-financed COVID relief bills aren’t denting demand or visibly inducing concerns about Uncle Sam’s creditworthiness. Even with the recent uptick, yields remain near generational lows, keeping that new debt affordable. Think through that 30-year auction—the Treasury will be paying 2.23% on that tranche of debt until 2051. That is a wonderfully long time to lock in low funding costs.
As vaccine distribution becomes more widespread, many economists are becoming increasingly optimistic about economic growth. One factor underlying the excitement: Households are sitting on a massive pile of savings. Some see this as dry powder that will power an economic recovery for a long time to come. But households are unlikely to spend all these savings, and we think sentiment toward this alleged mountain of pent-up demand is a key place to watch for frothy expectations.
According to a recent Bloomberg analysis, households worldwide have accumulated $2.9 trillion in new savings since the pandemic hit, with the US comprising about half that amount ($1.5 trillion) as personal savings rates soared.[i] While the government’s direct household payments have contributed, the stockpile also reflects a lack of spending, particularly on services and travel, due to COVID restrictions.
Now, with economies poised to reopen more fully as vaccines roll out, some see these savings as jet fuel for economic growth. One research outfit estimates that if households ran down built-up savings in full, GDP could grow 9% in 2021.[ii] In that scenario, GDP would be about 5% higher than its pre-pandemic 2019 level.[iii] While possible, that extreme outcome seems a wee bit unlikely to us—especially since US GDP ended 2020 only -3.5% below pre-pandemic levels, and growth slowed in Q4 as the post-lockdown snapback ran its course.[iv]
“The best single measure of where valuations stand at any given moment.”[i] That is how the Sage of Omaha, Warren Buffett, described the ratio of US stock market capitalization to nominal GNP in late 2001. Today, GDP has replaced GNP as the standard economic output measure globally.[ii] Hence, many cast market cap to nominal GDP as the “Buffett Indicator,” lumping it with P/E ratios and other valuations as a gauge of whether stocks are overvalued. Now it has smashed through early 2000’s peak—a bad omen, allegedly. But we see several problems with presuming this metric predicts a shift in the market cycle. Here is a close inspection.
The alarm’s alleged cause: US-listed stocks’ market cap, as measured by the Wilshire 5000 Index, is approaching twice America’s GDP, far above the dot-com bubble’s 1.4 high. (Exhibit 1) After initially plunging in last year’s bear market, the Buffett Indicator has surged higher. That move higher is partly the result of lower GDP, which hasn’t fully recovered its first-half 2020 tumble yet. Meanwhile, stock prices are well beyond pre-pandemic highs, pushing market cap way up. Many pundits see this as yet another factor indicating markets are frothy—detached from economic reality.[iii]
Exhibit 1: The Buffett Indicator
Source: FactSet and Federal Reserve Bank of St. Louis, as of 3/9/2021. Ratio of Wilshire 5000 Total Market Capitalization Index to nominal GDP, Q1 1985 – Q4 2020.
Stop us if you have heard this one before: Long-term interest rates’ recent jump is only the beginning, setting up good times for value stocks and bad times for fixed income investors. Stock investors are salivating at the prospect of cyclical categories like Financials racing ahead, and as several articles noted Monday, short positions in US Treasurys are at record levels. In our view, it all seems very characteristic of short-term moves—the kind destined to fade fast.
Because of bonds’ safe haven reputation, it is easy for many to forget that bonds, like stocks, are volatile. They have less expected short-term volatility than stocks, but they still wiggle plenty and are prone to sharp sentiment-driven pullbacks. We think this is what bonds are experiencing today, rather than a lasting move.
Sentiment toward bonds right now reminds us an awful lot of sentiment toward stocks during a typical correction. In stocks, we would define that as an emotion-driven move of around -10% to -20%. Stock corrections can start for any or even no apparent reason, and they usually begin and end without warning. Sentiment plunges quickly, prompting investors to make knee-jerk reactions in hopes of avoiding worse pain to come. For some, that means ditching stocks. For others, that means rapidly adding short positions. Either would qualify as evidence of capitulation—abandoning hope of a near-term recovery and incorporating the reigning fears into portfolio decisions. Corrections usually end as this process reaches fever pitch and all the negativity gets priced in, setting the stage for a fast rebound that catches people flat footed.
For most of the last two weeks, inflation worries and interest rate gyrations have dominated the financial press. So it was Thursday, as many investors watched a Wall Street Journal Q&A session with Fed head Jerome Powell. Many expected Powell to drop hints about how the Fed may (nonsensically, in our view) push back against rising long-term interest rates. He offered little on this front, though. However, in a refreshing turn, he did make some very sensible points about upcoming inflation data that we think investors would do well to take to heart now—ahead of next week’s US Consumer Price Index (CPI) release and those in the months immediately to come.
The comments we are referring to came early in the Q&A. Mr. Powell started by summarizing where the US economy is today, in the Fed’s estimation. After running through a recap of the Fed’s dual mandate to balance maximum employment and price stability, he discussed the state of employment. Then it was on to inflation. Here is an excerpt.
So right now inflation is running below 2 percent, and it’s done so since the pandemic arrived. We do expect that as the economy reopens and hopefully picks up, we’ll see inflation move up through base effects, which means just that the very low readings of March and April will fall out of the 12-month window, and also through a surge, if you will, in spending that may come as the economy fully reopens. And that could create some upward pressure on prices. The real question is how large those effects will be and whether they will be sustained or more transitory.
Editors’ Note: Our political commentary is non-partisan by design. We favor no political party nor any politician and assess political developments for their potential economic and market impact only.
UK Chancellor of the Exchequer Rishi Sunak unveiled the 2021 Budget on Wednesday, outlining projected fiscal policy for the next five years. And with that, the UK became the first major nation to attempt to address the question, how will they pay for that massive mountain of COVID relief spending? The answer, at first blush, is “austerity.” That is how a lot of headlines and politicians summed up the package of tax hikes and apparent spending cuts. In our view, though, there is a bit more here than meets the eye. To us, this is a budget that, aside from a near-term stealth income tax hike, leaves a lot of wiggle room before the big moves kick in … and really only takes the borderline obvious move of curtailing emergency pandemic spending. Heck, considering most of the tax provisions discussed today don’t take effect until the year before the next election—presuming Parliament even approves them—we wouldn’t be at all surprised if this turned out to be a lot of near-term sound and fury with little eventual substance. Not that any of this is make or break for UK stocks, but we can see plenty of room for a better-than-expected outcome to lift sentiment.
The figure getting the most ink in Wednesday’s coverage was £470 billion. That is how much money the Treasury is projected to have spent on COVID assistance once all is said and done. Echoing sentiment following Britain’s fiscal response to 2008’s global financial crisis, UK headlines and politicians alike were focused on solving the how to pay for it problem as soon as possible—a notable change from the US and much of Continental Europe, which seem content on kicking the can for a while longer. Looking at the Treasury’s Budget report, we think Her Majesty’s Treasury probably has plenty of latitude to do the same if politicians preferred that path. For it isn’t the total amount of debt outstanding that really matters to public finances, but how much the Treasury has to spend servicing it.
March is just two days old, and already it has brought a flurry of COVID vaccine-related news—refueling hopes for an economic boom as society gains immunity to the virus and the world can finally reopen. Across most think tanks and official forecasters, expectations for fast growth abound—not just for 2021, but for 2022 and beyond. Conventional wisdom holds that this will benefit all the traditional value industries, including Industrials and Energy. Not coincidentally, value stocks have popped again lately. We have written before why we expect growth stocks to keep leading overall as this bull market rolls on, notwithstanding some sentiment-driven wiggles along the way—and we won’t rehash that full argument here. But we do think it is worth noting that value enthusiasm seemingly ignores a lot of fundamental headwinds plaguing value-heavy sectors and industries. Considering stock categories generally do best when worried investors underrate opportunity, the current scenario doesn’t seem to augur well for value.
To see this in action, consider air travel—widely believed to be on the cusp of a post-COVID boom as people worldwide unleash their pent-up wanderlust. At a consumer level, this is possibly true, to a degree. Many folks are sick of confinement and, with savings rates remaining sky-high, many probably have the spare cash to fund a jaunt to their favorite tropical beach, theme park, international metropolis or mountain adventure. But when an event pulls consumption forward or pushes it back, like Japanese sales taxes in recent years have two times, the burst doesn’t usually prove lasting. In this case, we are a little skeptical a potential reopening resurgence in consumer travel demand would amount to a new, higher, lasting trend. Markets are quite well aware of this theory too, suggesting these expectations are reflected in stock prices now—and likely to a great extent.
Regardless, though, business travel doesn’t seem to have as much immediate mojo. A recent study, highlighted in Bloomberg Tuesday, showed total global spending on business travel dropped from $1.43 trillion in 2019 to just $694 billion last year, and it projects a rather ho-hum recovery.[i] The projected 21% growth for 2021 would leave it -42% below 2019’s peak.[ii] The researchers don’t anticipate business travel regaining its pre-pandemic peak until 2025. Turns out meetings that used to require jet setting can accomplish as much over video conference, helping businesses free up cash for other endeavors.
Interest rate jitters took on a new flavor late last week, when the 10-year US Treasury yield briefly jumped higher than the S&P 500’s dividend yield. If bonds pay more than stocks, the thinking goes, then there is no alternative goes out the window as a thesis to own stocks. People investing for income will allegedly flip from dividend-paying stocks back to bonds, removing one of this bull market’s—and the 2009 – 2020 bull market’s—supposedly key drivers. We have long seen these pure yield chasers as mostly mythical, considering people whose long-term goals and time horizon require low expected volatility probably won’t rush headlong into a more volatile asset class for its yield alone. But philosophy isn’t the only strike against that thesis. Throughout history, bond yields have topped dividend yields much, much more often than not, and we don’t see any evidence that has been bearish for stocks.
Exhibit 1 shows the S&P 500’s dividend yield and 10-year US Treasury yield since 1995, which is as far back as daily data go. As you will see, the last 11-ish months are an anomaly. Before that stretch, dividend yields topped bond yields consistently only eight times—twice during stock bear markets and six times during bull markets. That split and the overall rarity, in our view, is your first hint that this isn’t a significant market driver.
Exhibit 1: A Brief History of S&P 500 Dividend Yields and Bond Yields
Thursday, US 10-year Treasury yields continued a recent jump higher, hitting 1.49% at the close—their highest level in a year.[i] Many blame this jump for the day’s -2.5% S&P 500 selloff—and worry there is more to come.[ii] But in our view, this is an extremely hasty conclusion to reach. For one, we don’t expect yields to end 2021 much higher than current levels, and they may even give up some of the recent rise. But even if they do climb from here, the idea this is automatically a problem for stocks is bogus logic.
First, stay cool. Short-term volatility is part and parcel of even the best bull market years. Getting carried away and extrapolating recent rate-and-stock swings forward is a common investing error too many folks make. Yes, last August, 10-year Treasury yields hit a record low 0.5% before rising to 0.9% at 2020’s end.[iii] Yes, consensus expectations were for another small rise in 2021, with the median forecast eyeing a 1.2% 10-year yield at year end.[iv] Yes, rates are above that level now. But projecting much more from here based on this move is risky business.
Part of the reason why: The recent jump looks mostly like a sentiment-based move—one unlikely to last or extend from here. We don’t see a sudden, material change in bond supply and demand fundamentals. On the supply side, there is currently a dearth of long-term Treasury issuance. Although Uncle Sam’s borrowing exploded in 2020, more than 80% of its record-breaking $21 trillion worth of debt sales were for one year or less and over 90% for five years or less.[v] Some speculate this will reverse with the government selling more longer-dated bonds. But judging by the Treasury Borrowing Advisory Committee’s recommended financing tables for Q1 and Q2, issuance is set to stay concentrated at the short end for the foreseeable future.[vi]
If you drew a Venn Diagram involving short sellers, retail traders, social media posts, newfangled brokerages, boring stock clearing technicalities, a possibly beleaguered mall retailer and a Congressional committee, we think you would find only one point of intersection: last week’s House Financial Services Committee (HFS) hearing entitled, “Game Stopped: Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide.” It was an investigation, HFS Chair Maxine Waters said, into whether regulations were needed following the late-January surge-and-crash in a number of “meme” stocks. We watched this endlessly entertaining five-plus-hour hearing so you didn’t have to. What follows is our summary of the highlights and lowlights. You can decide which is which.
Before we go further, please consider our disclosure: This piece will meander through the happenings in a Congressional committee hearing. Along the way, it will discuss a few individual securities. Please remember that MarketMinder doesn’t make individual security recommendations. The piece will also, by nature, touch on politics. Our commentary in this regard is intentionally non-partisan and aims solely to explore how these issues intersect with markets.[i]
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