Hey all,
I wanted to post a few thoughts of the somewhat educational variety. Hopefully this will help with perspective on where we've been and why I continue to see equity market weakness for the extended and foreseeable future (1-3 years maybe). So starting with this chart, this is the 10 year US Treasury yield below and the S&P 500 index above going back to approx. 1980. It's log scale to make each asset more meaningfully represented. What we notice about the 10 year yield relative to equities throughout this ENTIRE 40+ year period is that it has been on a steady declining slope as the S&P has seen significant growth and gains. The numbers for each over this stretch are as follows.
10 Yr Yield High: 16% (nearly) in Sep '81
10 Yr Yield Low: .33% in March '20
S&P 500 Low: 100 (roughly) in March '80
S&P 500 High: 4820 in Jan '22
Actually this is really interesting and I didn't realize this till now running these numbers. The 10 year yield has contracted by 48x while the S&P 500 has gained 48x over the same period... A note on falling rate environments....they're bullish for stocks. We have been in this period of steadily lower rates over time to the tune of 48x and the stock market reflects this favorable environment with the exact same multiple in growth over the same period.
Now, we all know that the FED is on a mission to tame inflation with higher interest rates..Take note of the 10 year low in Mar '20 of .33%. I believe that low will hold for the remainder of our trading careers as we see a period of steadily INCREASING rates to counter this 40 YEAR accommodative run. In the short-med term sure the FED is looking to boost into the 3-3.5% range for their target rate. Be advised that 3% is 6% shy of June CPI (9%) which puts us still in a REAL accommodative rate environment. They're gonna have to match inflation (with target rate) and then some to have it sustainably reverse course. CPI could come down as part of this process and I think it will. Let's say it fall to 6%. Better, right? We'd still need a fed target rate at 7% + to meaningfully throw water on inflationary forces. I guess what I'm saying is...3.5% is a neat target, but we'll have much higher to go beyond that. I see this as a give and take over the coming years as rates make new highs which puts equities in a tough position until this process plays out. I'm kind of looking at 2000-2003 period of multiple contraction post dot com bubble as a reference for this current environment. Sorry, the bottom is not in and it could take years to get there.
Ok all that said I wanted to also clarify some things regarding Quantitative Easing and what it actually means when we say the Fed is "Printing" Money. The Fed engaged in QE first time around in November 2008. I remember pretty well as I was working in Midtown Manhattan for an asset management firm and we were in the thickest part of the financial crisis. CNBC was on perpetually for our desk of sales people...Anyway I see a lot of folks referencing FED printing and their balance sheet but often the context or implication of this concept is apparently misunderstood by many in TV chats and comments. Being a nerd, and having worked for the largest bond manager during the first QE, the firm was with was instrumental in helping guide the fed through that stretch...I'm gonna lay out how QE works for all to observe (if you are not clear already).
Quantitative Easing (QE) is when the FED purchases US Treasuries and or US mortgage backed bonds from the open market. The real purpose of this strategy is to lower or maintain low borrowing rates for the US Gov, US mortgage borrowers (homeowners) and by extension bc the US Treasury is the benchmark, all debt and borrowing rates. QE is typically employed as a supplemental strategy once the actual FED target rate is at or near 0%...can't go lower right? Wrong, kinda....this is where the FED would likely utilize QE if rates at 0 but they still wanted to do more to stimulate growth/be accomodative. When the FED buys US treasuries or mortgage backs, it sends those yields lower. This rate influence impacts the entire bond and rates markets by extension as a lower benchmark bc there's a huge buyer of US bonds! the FED to the recent tune of $9 Trillion. I'll pose the question..."where'd they get the money?" They just kind of acted as if they had it....and bought the bonds...and held em. Without actually printing it, the impact of this is as if there were 9T more dollars in circulation and far more demand for treasuries than is reality.... They lowered interest rates without changing their target rate (which was already at 0%) and did so by theoretically "printing" the money to make the purchases. That's it, that's QE. Worth mentioning that we are now in QT (tightening) and they are selling those same bonds back effectively removing the "as if" 9T from circulation.....it never really was in circulation but QE simulates as if it were...This selling of US Treasuries and MBS is what they refer to as reducing or unwinding their balance sheet. $95 B/ month currently I believe.. Bear in mind that these sales will have the opposite impact on rates as the purchases so while the fed is raising their target rate 50-75bps per meeting, there is an additional impact on the bond market from QT.... If you read this far my hat's off to you. Hopefully someone learned something...thanks
~B