Wednesday, July 13, 2016

Aging Bull Charging Again

Sylvester Stallone celebrated his 70th birthday on a yacht in Saint-Tropez on Saturday. The film star has appeared in seven “Rocky” movies about fictional underdog-to-champ boxer Rocky Balboa. In the latest one, “Creed” (2015), he was too old to box, so he coached instead.

Like Rocky, the current bull market is aging, but still putting up a great fight. It started on March 6, 2009 on an intraday basis, when the S&P 500 touched 666. As of yesterday’s close, it is up 216%. Not bad for a seven-year-old bull. An actual bull can live from 5-15 years, depending on how well behaved he is and how his libido and fertility rate hold up over time. There has been much chatter and even smirking lately about the inability of the bull to charge ahead to new highs after last doing so on May 21, 2015. Apparently, the recent drop in the 10-year Treasury bond yield was the little blue pill that boosted the libido of the bull.

Almost since the start of the bull market, I have observed that it has been a series of panic attack corrections followed by relief rallies to new cyclical highs and then new record highs (exceeding the October 9, 2007 previous record peak) since March 28, 2013. Investors were traumatized by the financial crisis of 2008. So it doesn’t take much to convince them that the world is coming to an end imminently.

Of course, the major central bankers were also traumatized by the event. It doesn’t take much to convince them that they must provide another round of ultra-easy monetary policy to avert a repeat of the financial crisis of 2008. Everyone’s primal fear is that the next crisis will be the widely dreaded “Endgame” scenario--a financial crisis unstoppable by central bankers who have run out of ammo.

The latest relief rally is notable because the preceding panic attack was so fleeting. The Brexit shocker caused a two-day selloff in the S&P 500 of just 5.3% during Friday, June 24 and Monday, June 27. Since then, it rose into record-high territory. Markets hate uncertainty. However, the uncertainty caused by the unexpected vote in the UK to leave the EU also increased the likelihood of more easing by the overseas central bankers, particularly the Bank of England. The odds of a Fed rate hike over the next 12 months dropped to zero, according to the federal funds rate futures market. In other words, the bull still gets charged up on the mantra: “Don’t fight the central banks.”

The bond market certainly isn’t fighting the central banks. Stock investors have to be especially impressed that the 10-year Treasury yield remains below 1.50% despite Friday’s stronger-than-expected payroll employment report and the rally to new highs in stocks. Of course, leading the charge have been interest-rate-sensitive stocks. Previously, I observed that negative interest rates in the Eurozone and Japan are the black holes of the global credit market, creating a gravitational force field that was pulling down US bond yields. I scooped a similar story in the 7/10 WSJ titled “Black Hole of Negative Rates Is Dragging Down Yields Everywhere.” Here is the main point of the article:
Yields in the U.S., Europe and Japan have been plummeting as investors pile into government debt in the face of tepid growth, low inflation and high uncertainty, and as central banks cut rates into negative territory in many countries.

Even Friday, despite a strong U.S. jobs report that helped send the S&P 500 to nearly a record, yields on the 10-year Treasury note ultimately declined to a record close of 1.366% as investors took advantage of a brief rise in yields on the report’s headlines to buy more bonds. Yields move in the opposite direction of price.

As yields keep falling in these haven markets, investors are looking for income elsewhere, creating a black hole that is sucking down rates in ever longer maturities, emerging markets and riskier corporate debt.
Here is what I wrote about this same subject on February 5, 2015:
At the beginning of last year, most bond investors were bearish because they expected the Fed would taper and then terminate QE, which is what happened last October. Then bond investors anticipated that the Fed might start raising interest rates by the middle of this year. This could still happen. However, it might be one-and-done for Fed rate hikes this year. If so, then US bond yields might continue to fall, driven lower by the gravitational pull of German and Japanese yields. Rather than decoupling, they might remain very much coupled.
Back then, the US 10-year government bond yield was at 1.83%, while the comparable German and Japanese yields were 0.37% and 0.36%. Yesterday, the US yield was at 1.53%, while the German and Japanese yields were -0.09% and -0.29%.

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