Are bonds driving the ship?
Updated
Liquidity is the whole ballgame
As I've watched the market rip higher amid massive federal deficits, extremely low taxes, and extremely low interest rates over the last several years, I've experienced a growing conviction that "liquidity is the whole ballgame" where markets are concerned. You can chart stock market performance largely as a function of how "tight" or "easy" monetary policy is. Even the US badly losing a trade war to China and then getting locked down by a global pandemic couldn't keep this market down.
Liquidity is controlled by the Fed and bond market, and inflation is the limit
To a great extent, monetary policy is controlled by the Fed, and the Fed's mandate is to control inflation. So investors have definitely reacted negatively to rising inflation and Fed talk of eventually "tapering" asset purchases and raising interest rates. To be sure, the private market ultimately sets bond rates. Bond investors may demand higher interest rates if they see inflation coming, and lenders may demand higher interest rates on mortgages and consumer credit, too. But the private bond and lending market responds to signals from the Fed, so Fed policy and bond investor behavior go hand in hand. The bond market tries to anticipate the Fed and can be viewed as a leading indicator of what the Fed will do.
Rising rates in early 2021 were bad for growth stocks and good for financials
In the first months of 2021, bond rates rose sharply as inflation expectations rose and investor demand for low-interest bonds dried up. Technology stocks, especially unprofitable growth stocks like those held by Cathie Wood's ARK funds, sold off along with bonds. (Higher interest rates make it harder for unprofitable growth companies to raise capital through low-interest debt.) Meanwhile, financial stocks and highly profitable "cash cows" outperformed. (These companies are net lenders rather than net borrowers, so they tend to benefit from higher yields.)
Basically, if you think the Fed will continue to pump liquidity into the system forever, you should bet on cash flow-negative bubble stocks like Cathie does. If you think liquidity's days are numbered, you should short ARKK and go long on Goldman Sachs.
Liquidity rebounded in mid-March, but can it last?
The bond selloff bottomed March 18, and since then, both bonds and growth stocks have made modest recoveries as yields eased. Partly this is just regression to the mean, and partly it may be that bond investors believed the Federal Reserve's narrative that inflation is "transitory" and that we won't need to taper asset purchases or raise interest rates until 2023.
But inflation expectations have continued rising, and official inflation data have lately been surprising to the upside. The Citi inflation surprise index is at its highest level in 13 years. The dollar has been weakening, and foreign purchases of US treasuries have almost entirely dried up. The Russian government announced today that it will sell its reserves of US dollars and replace them with other nations' currencies. The dollar reserve system that made the last decade of "easy" monetary policy possible looks to be at risk.
And the Fed is sluggishly beginning to respond to these warning signs. Regional Fed presidents Robert Steven Kaplan and Patrick Harker have been vocally calling for the Fed to start thinking about "tapering" bond purchases, and yesterday the Fed announced that it is, in fact, winding down one pandemic program to purchase corporate bonds. (But this is not a signal about tapering, they insisted to the press!)
For now, Fed funds rate futures continue to price the odds of an interest rate hike in 2021 at less than 10%. But in April alone we saw month-over-month inflation of 0.8%, bringing the trailing 12 months' inflation rate to 4.2%. And 0.6% seems to be the consensus for the next two months, which would bring July's trailing 12 months' inflation rate to 4.9%. The Fed probably can't ignore 5% inflation for long. (And really it's a 7-10% inflation rate right now if you annualize the rates for March-July instead of adding up the rates for the trailing 12 months.)
The technicals are flashing warning signs
Although bonds have rallied since March 18, they hit a ceiling in the $140.50 - $141 range. They've also been unable to hold above their 50-day EMA or their 200-week EMA. Presently TLT is below all its major moving averages not only on the hourly chart, as shown above, but also on the weekly and daily charts:
Note that TLT is still within the green triangle, but it is fast approaching a decision point. Also note the bearish hidden divergence on the RSI, which would tend to favor a downward breakout from the triangle. Recent strong economic data, including this morning's blowout payroll report, paint a picture of a strong economy and may lead to faster tapering by the Fed. That's one reason that both stocks and bonds sold off today despite the positive economic data.
Sentiment is bearish
I'm not the only one feeling bearish on bonds right now. The put/call ratio on TLT, is 1.8, significantly worse than the 30-day average of 1.4. And investors seem to expect the indices to sell off as well. SPY has a 1.9 put/call ratio, in line with the 30-day average, and QQQ has a 2.0 put/call ratio, only slightly better than the 30-day average of 2.1. The put/call ratio for ARKK has recently improved, down to 1.5 from the 30-day average of 1.8. But if I'm right that a bond sell-off would disproportionately affect growth stocks, then ARKK's put/call ratio may turn bearish again if TLT breaches the bottom of this triangle. ARKK's price action the last few days certainly doesn't look good:
As I've watched the market rip higher amid massive federal deficits, extremely low taxes, and extremely low interest rates over the last several years, I've experienced a growing conviction that "liquidity is the whole ballgame" where markets are concerned. You can chart stock market performance largely as a function of how "tight" or "easy" monetary policy is. Even the US badly losing a trade war to China and then getting locked down by a global pandemic couldn't keep this market down.
Liquidity is controlled by the Fed and bond market, and inflation is the limit
To a great extent, monetary policy is controlled by the Fed, and the Fed's mandate is to control inflation. So investors have definitely reacted negatively to rising inflation and Fed talk of eventually "tapering" asset purchases and raising interest rates. To be sure, the private market ultimately sets bond rates. Bond investors may demand higher interest rates if they see inflation coming, and lenders may demand higher interest rates on mortgages and consumer credit, too. But the private bond and lending market responds to signals from the Fed, so Fed policy and bond investor behavior go hand in hand. The bond market tries to anticipate the Fed and can be viewed as a leading indicator of what the Fed will do.
Rising rates in early 2021 were bad for growth stocks and good for financials
In the first months of 2021, bond rates rose sharply as inflation expectations rose and investor demand for low-interest bonds dried up. Technology stocks, especially unprofitable growth stocks like those held by Cathie Wood's ARK funds, sold off along with bonds. (Higher interest rates make it harder for unprofitable growth companies to raise capital through low-interest debt.) Meanwhile, financial stocks and highly profitable "cash cows" outperformed. (These companies are net lenders rather than net borrowers, so they tend to benefit from higher yields.)
Basically, if you think the Fed will continue to pump liquidity into the system forever, you should bet on cash flow-negative bubble stocks like Cathie does. If you think liquidity's days are numbered, you should short ARKK and go long on Goldman Sachs.
Liquidity rebounded in mid-March, but can it last?
The bond selloff bottomed March 18, and since then, both bonds and growth stocks have made modest recoveries as yields eased. Partly this is just regression to the mean, and partly it may be that bond investors believed the Federal Reserve's narrative that inflation is "transitory" and that we won't need to taper asset purchases or raise interest rates until 2023.
But inflation expectations have continued rising, and official inflation data have lately been surprising to the upside. The Citi inflation surprise index is at its highest level in 13 years. The dollar has been weakening, and foreign purchases of US treasuries have almost entirely dried up. The Russian government announced today that it will sell its reserves of US dollars and replace them with other nations' currencies. The dollar reserve system that made the last decade of "easy" monetary policy possible looks to be at risk.
And the Fed is sluggishly beginning to respond to these warning signs. Regional Fed presidents Robert Steven Kaplan and Patrick Harker have been vocally calling for the Fed to start thinking about "tapering" bond purchases, and yesterday the Fed announced that it is, in fact, winding down one pandemic program to purchase corporate bonds. (But this is not a signal about tapering, they insisted to the press!)
For now, Fed funds rate futures continue to price the odds of an interest rate hike in 2021 at less than 10%. But in April alone we saw month-over-month inflation of 0.8%, bringing the trailing 12 months' inflation rate to 4.2%. And 0.6% seems to be the consensus for the next two months, which would bring July's trailing 12 months' inflation rate to 4.9%. The Fed probably can't ignore 5% inflation for long. (And really it's a 7-10% inflation rate right now if you annualize the rates for March-July instead of adding up the rates for the trailing 12 months.)
The technicals are flashing warning signs
Although bonds have rallied since March 18, they hit a ceiling in the $140.50 - $141 range. They've also been unable to hold above their 50-day EMA or their 200-week EMA. Presently TLT is below all its major moving averages not only on the hourly chart, as shown above, but also on the weekly and daily charts:
Note that TLT is still within the green triangle, but it is fast approaching a decision point. Also note the bearish hidden divergence on the RSI, which would tend to favor a downward breakout from the triangle. Recent strong economic data, including this morning's blowout payroll report, paint a picture of a strong economy and may lead to faster tapering by the Fed. That's one reason that both stocks and bonds sold off today despite the positive economic data.
Sentiment is bearish
I'm not the only one feeling bearish on bonds right now. The put/call ratio on TLT, is 1.8, significantly worse than the 30-day average of 1.4. And investors seem to expect the indices to sell off as well. SPY has a 1.9 put/call ratio, in line with the 30-day average, and QQQ has a 2.0 put/call ratio, only slightly better than the 30-day average of 2.1. The put/call ratio for ARKK has recently improved, down to 1.5 from the 30-day average of 1.8. But if I'm right that a bond sell-off would disproportionately affect growth stocks, then ARKK's put/call ratio may turn bearish again if TLT breaches the bottom of this triangle. ARKK's price action the last few days certainly doesn't look good:
Note
One thing that might argue for the bulls on bonds is that the Fed bought more bonds this week than any other week since December. That may indicate that they're doing soft yield curve control to try to hold bonds at these support levels. In December that tactic ultimately failed, but it may account for some of bonds' apparent indecision this week.Note
Job report this morning missed expectations, and labor force participation rate was down. That will probably be bullish for TLT today.Note
And, indeed, that's an upside breakout from the triangle at the open. Note
In another data point for the bond bulls, Cleveland Fed President Loretta Mester told the press that today's jobs number wasn't good enough to shift Fed policy toward tightening.Note
Treasury Secretary Janet Yellen says the US government needs to spend more to get inflation running hot, and if it leads to higher interest rates then that would be "a good thing" for the US and for the Fed. Lots of headlines are taking this out of context a bit: "Higher interest rates would be good for the country, Treasury Secretary Yellen says." Will be interesting to see if this moves TLT downward at the open on Monday.Note
TLT is testing the 140.50 resistance level today. Note
Treasuries broke out to the upside today, although the intraday price action suggests some hesitancy about the move:We still have an important test tomorrow morning when the CPI data comes in. I will be watching to see if this breakout holds after that data release. But as long as it holds, I think basically the bond market is flashing a signal that tech/bubble/growth trades are on, and value/financials trades are off. Financials pulled back beneath breakout level today:
ARKK has not yet broken out above its 50-day EMA, but it's had a bullish trend line break, and it's working on a bullish moving average cross. It will make its final decision tomorrow morning after the CPI report, I expect.
Note also the bullish trend line break in the QQQ/SPY ratio:
Note
This morning's data release showed inflation substantially hotter than expected, likely bearish for both bonds and stocks. It's somewhat counteracted by worse than expected initial jobless claims, which argues for continued accommodative monetary policy.Note
Today TLT will decide whether to hold this breakout level. So far, so good.Note
There was an inflation survey out this morning that showed that inflation expectations have increased by 0.2% month over month. As a result, bonds opened lower. They have rallied to breakeven for the day, but possibly they could close the day lower. Home prices also increased more than expected in April, which points to hot inflation as well. Bonds still have a constructive technical setup, and a lot of commodities are still selling off, so it remains to be seen what bonds will do. Stock market movement will depend on bond market movement from here.
I think financials are a decent bet, because even if bonds don't start to sell off, financials have a positive catalyst from massive dividend hikes by all the major S&P 500 banks. And if bonds do start to sell off, then you capture that move.
Homebuilders have some vulnerability to rising rates, but they have a positive catalyst in rising home prices and extension of the federal eviction mortarium. So that's potentially another place to hide out.
Natural gas prices are soaring, so I'm tempted to buy natural gas cos, but any increase in interest rates might cause natural gas and oil to experience a downturn.
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