Peak Liquidity Portends Trouble for Risk Assets -John Authers
the rumors of the demise of the bond market (the '40' in the 60/40) continues to be greatly exaggerated
Barrons story this weekend citing Jim Paulsen declaring WHY bonds look like a BAD BET.
… Looking over that near-century of data, the 10-year yield was below 3% about one-third of the time, he found. When it was above that line, bonds did a good job as portfolio diversifiers, with little reduction in return but a significant cut in volatility. Conversely, when yields were under 3%, shifting from stocks to bonds in order to dampen volatility exacted a heavy penalty in returns.
When the 10-year Treasury was under 3% (as it is now, at 1.53%), stocks averaged a monthly return that generated a blazing 16.9% per annum while bonds averaged just 2.8% (which now seems princely). Shifting to the classic 60/40 balanced portfolio cut the return to 11.1%, or by about two-fifths, in exchange for about a one-third reduction in volatility.
… But TIPS might not be the answer for the future. According to TS Lombard analysts, inflation pressures may be peaking, while future Fed rate increases will lift real yields from their structural lows. The past 10 Fed hike cycles have boosted real yields an average of 0.90% a year after liftoff. And in the last cycle, TIPS ETFs saw outflows, making the sector “particularly vulnerable” after these funds’ record inflows of $9.1 billion in the past six months, they write in a research note …
Jim Paulsen. TS Lombard. Wait, no it was Mark Grant’s idea first. Just ask him. As folks are falling all over themselves to be the first to have told us so, it would then, in my humble view, become incrementally MORE difficult for a bond market bubble to actually become a thing.
With such complete and abject hatred of an asset class and investment strategy over the years NOW resulting in strategist all-stars declaring things like TINA and FOMO in these days of YOLO, bonds are nowhere to be found. Simply NOT part of the equation any longer.
Except in times of stress and risk off and a demand for securities which offer some comfort. A release valve. Enter this mornings VIEW from John Authers of Bloomberg with an excerpt and visual which caught MY eyes
…Investors need a plan of action for when the shoe of higher real yields finally drops.
…To the extent that liquidity growth drives the economy, the numbers tell much the same story as economic surprise indexes and the Treasury market. Reducing liquidity, falling nominal yields, and a petering out of positive economic surprises are all consistent with economic growth fading and potentially a tough time for risk assets:
AND Authers then dips into the well of sell-side stratEgery and offers this view of causality from BAML
… But if this interpretation is right, the equity market hasn’t got the lesson yet. As BofA Securities Inc. points out, on a rolling 10-year basis, equities are beating bonds in the U.S. by the most since 1964:
But WAIT, there’s MORE (from both Authers and BAML) as he digs up an oldy and goody — a long term view of RATES
… Here we need to remember that when inflation rises, the gap between real and nominal measures tends to widen, and it becomes more important to track the real numbers. After all, real and not nominal yields are what central banks try to influence. And real yields are shockingly low. I’ve offered various illustrations of this in recent weeks. Here is a good chart of the real U.S. 10-year yield from BofA, going back to when Alexander Hamilton was running the Treasury department:
It’s slightly reassuring that there are many precedents for negative 10-year real yields. It’s less reassuring to see that they were all associated with times of war, or serious financial crises. The progress of real yields over the last year is also strange …
Okie Dokie, then … Watching whatever happens to REALZ for clues and whatever the incoming (new/pre-existing)Fed chair will do ‘bout em.