Stocks Finally Give Bonds Some Respect. Or Not.
(Bloomberg Opinion) -- At one point Thursday, the MSCI All-Country World Index of equities was down as much as 1.43 percent, making it one of the worst days in the stock market this year. Most tied the slump to the big sell-off in the global bond market, which has pushed borrowing costs to their highest since 2013 on average. That’s certainly plausible for many reasons, but it sort of ignores the fact that the bond market has been sliding for more than two years with little impact on equities.
Since bottoming at 1.07 percent on July 5, 2016, the average bond yield has steadily climbed, reaching 2.20 percent on Wednesday as measured by the Bloomberg Barclays Global Aggregate Bond Index. In that time, bonds generated a cumulative loss of 2.95 percent as debt prices fell, compared with a gain of 31.7 percent for the MSCI index. Plus, bond yields are still low by historical standards, coming in at less than a third of where they were during the go-go years of the late 1990s. So something else must also be going on with stocks. Just take a look at some of the worst hit sectors in the stock market, such as technology-related shares, which are about as insensitive to interest rates as they come. As Bloomberg News’s Arie Shapira points out, that ties into an exclusive report by Bloomberg Businessweek that China used tiny microchips to infiltrate top U.S. technology companies including Amazon.com Inc. and Apple Inc. Amazon, Apple, and another company mentioned in the article, Super Micro Computer Inc., disputed summaries of Bloomberg Businessweek’s reporting. Regardless, Vice President Mike Pence laid out allegations of Chinese election interference in a harshly worded speech Thursday. The comments signaled a firmer U.S. pushback against Beijing as trade anxiety weighs on the looming midterm congressional elections, according to Bloomberg News’s Toluse Olorunnipa and David Tweed.
Up to this week, stocks had largely ignored an escalating trade war between the world’s two largest economies, betting neither side would want to see conditions get to the point of no return. To be sure, we’re not at that point yet, but the latest geopolitical developments — and not just with China, but with Russia as well — suggest it’s time to get a bit defensive. The Institute of International Finance on Thursday lowered its global economic growth forecast for 2018 to 3.2 percent from 3.5 percent. “We see an escalation of the U.S.-China trade conflict as the principal risk to our outlook,” the IIF said in its report.
ANATOMY OF A BOND SELL-OFF
When markets move, it’s rarely for just one reason. On any given day multiple factors influence the value of financial assets. So trying to ascribe a single reason behind the recent sell-off in bonds is a bit foolish. In fact, the list of factors working against bonds is long. Bleakley Financial Group chief investment officer Peter Boockvar has perhaps the best, most comprehensive list of reason for the weakness in bonds: 1) Nominal GDP is strong, running in a range of 4 percent to 6 percent depending on your current assumptions. 2) Inflation expectations are rising, with those measured by 10-year Treasuries just 3.5 basis points from their highest since August 2014 amid rising wages, tariffs and commodities prices. 3) The U.S. is ramping up its borrowing by selling more bonds to finance a soon-to-be $1 trillion budget deficit. 4) The Federal Reserve is allowing the maximum of $50 billion of bonds to roll off its balance sheet per month, which translates to $600 billion annualized. 5) The European Central Bank has cut its bond purchases in half and plans to stop them altogether in three months with President Mario Draghi turning hawkish. 6) The Bank of Japan has cut its quantitative easing program in half and is now more tolerant of a steepening yield curve there. 7) Foreign investors have slowed their purchases of U.S. Treasuries to modest levels as the rising cost of hedging their dollar exposure erases any of the extra yield they’d get, especially for Japanese and European buyers. 8) Pension funds did most of their buying of longer-term U.S. Treasuries before a Sept. 15 deadline. Companies with an unfunded defined-benefit pension liability could take a deduction at the old 35 percent corporate tax rate if they funded it before Sept. 15. After that date, the deduction rate fell to 21 percent.
The rise in bond yields means that it’s going to become even more expensive for consumers to borrow. That’s a tough pill to swallow given that the average 30-year mortgage rate as measured by Freddie Mac is already at 4.70 percent, which is the highest since 2011. It may be small consolation, but it looks as if there may soon be some relief at the gas pump. West Texas Intermediate crude oil fell as much as 3.31 percent on Thursday from its highest since 2014. Prices fell after data provider Genscape Inc. was said to have reported that there is an additional 1.7 million barrels of oil stowed in tanks at a key U.S. pipeline hub in Oklahoma in the five days ended Oct. 2, according to Bloomberg News’s Samuel Robinson. That followed Wednesday’s U.S. government tally that showed nationwide inventories surged by the steepest margin since March 2017. Oil had rallied above $76 a barrel as shrinking output from Venezuela to Iran stoked worldwide concern about a supply crunch. U.S. President Donald Trump has repeatedly chided OPEC to lift output. Although oil-producing nations benefit during market rallies, prices that are elevated too high can imperil energy demand. “After the past few days of higher moves I think there’s increasing worry about the demand outlook,” John Kilduff, partner at Again Capital LLC, told Bloomberg News. Meanwhile, U.S. crude explorers pumped a record 11.1 million barrels a day last week, the Energy Information Administration said on Wednesday.
MARK YOUR CALENDARS
For the last few weeks it looked as if things were starting to look up for beleaguered emerging markets. Then this week happened. The MSCI Emerging Market Index of equities dived as much as 2.74 percent Thursday, the most since February, bringing its loss for the week to almost 4 percent amid the general “risk-off” environment outlined above. This week may end up just being a temporary setback if JPMorgan Chase & Co.’s Marko Kolanovic, the bank’s global head of macro quantitative and derivatives research, is to be believed. Kolanovic, who has dominated Institutional Investor’s annual rankings of top strategists for a decade or so, said in an interview Thursday on Bloomberg TV that emerging-market equities appear set to rally between 10 percent and 15 percent over the next three to six months as developing-nation assets close the performance gap with their U.S. peers. Kolanovic figures that key macroeconomic risks like the trade war are largely priced in to the asset class, while growth is on track to converge with the economic expansion in the developed world next year, reports Bloomberg News’s Ben Bartenstein. The S&P 500 Index has outperformed the MSCI Emerging Market Index by 21 percentage points this year as developing nations got battered by a strong dollar, rising U.S. interest rates and escalating trade tensions between the U.S. and China. But Kolanovic said he expects that trend to reverse. “We do think there’s more upside” in emerging markets, he said.
Amid the broad weakness in emerging markets Thursday, Russia stood out. The ruble weakened the most in almost two months, and the nation’s equities and bonds also fell. The moves reflect growing speculation that Russia may become even more isolated from the global economy after U.S. authorities accused seven Russian nationals of hacking attempts against anti sports-doping groups, the international soccer governing body and an anti-chemical weapons group, with the aim of disrupting efforts to investigate Russian activities. The hackers also sought access to systems operated by Westinghouse Electric Corp., a designer of nuclear power equipment, according to an indictment unsealed Thursday in federal court in Western Pennsylvania as reported by Bloomberg News’s Tom Schoenberg, Andrew Harris and Greg Farrell. Russia’s first bond auctions in more than a month proved that sanctions risk is still very much on the table. Russian bond yields jumped on Wednesday as the Finance Ministry canceled a planned auction of 10 billion rubles ($152 million) of short-term debt because of a “lack of acceptable bids” and failed to sell all the February 2024 debt offered in a separate auction earlier in the day, according to Bloomberg News’s Áine Quinn and Artyom Danielyan. “It wasn’t an inspiring result,” said Yury Tulinov, an analyst at Societe Generale SA’s local unit. “There still aren’t many buyers at these levels, which is a bad sign for the secondary market.”
The U.S. Labor Department on Friday will release its monthly report on the health of the job market. The consensus is that payrolls jumped by 185,000 in September, down just a smidge from August’s 201,000. Even so, there’s a growing sense that the actual numbers could be much higher. The top-ranked interest rates strategists at BMO Capital Markets pointed out in a research note Thursday that
nine proxies they track are positive for the report while just three are negative. Anecdotes from many employers suggest that the labor market is so tight that they are having trouble filling positions. If true, then expect to see an acceleration in the pace of average hourly earnings gains, which could further fuel concern that inflation is picking up, which would be negative for bonds and also equities given the moves in those markets this week.
Market Cycles Will Endure as Long as Humans Exist: Howard Marks
Emboldened Bond Bears Can’t Get Story Straight: Brian Chappatta
The Biggest Risk That Financial Markets Ignore: Noah Smith
The U.S. Economy Is on a Sugar High: Danielle DiMartino-Booth
Housing and Auto Stocks’ Woes Won’t Spread: Conor Sen
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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