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Can Stocks and Bonds Both Be Right? Actually, Yes

Can Stocks and Bonds Both Be Right? Actually, Yes

(Bloomberg Opinion) -- In September, as part of a Bloomberg Opinion series on the 10-year anniversary of Lehman Brothers’s collapse, I wrote about the huge buildup in global debt over the decade, to almost $250 trillion. At the time, the S&P 500 Index was on the verge of reaching its record high, the 10-year Treasury yield was about 3 percent, the yield curve was far from inverting and traders had priced in two more Federal Reserve interest-rate increases by the end of the year.

In other words, while the global figure was eye-catching, investors perhaps didn’t quite grasp the meaning of living in a “debt, debt, debt, debt world.” They’re starting to catch on now. My opening line, from September:  

“In many ways, all the talk about global central banks beginning a ‘great unwind’ of their extraordinary monetary stimulus is positively quaint.”

Fast-forward to the present. The Fed is no longer forecasting interest-rate hikes in 2019, and it’ll end its modest balance-sheet runoff by September — almost certainly earlier than Chairman Jerome Powell had envisioned. Across the Atlantic, the European Central Bank is diving headfirst into another round of stimulus (called TLTRO-III), which helped push 10-year German bund yields back below zero. The Bank of Japan isn’t pretending to tighten. Central banks in Australia and New Zealand have dropped hints that their next moves are more likely to be rate cuts. Markets are betting the Bank of England may do the same.

All of this matters because as the second quarter of 2019 begins, one of the most debated topics among investors is “whether stocks or bonds are right.” After all, the S&P 500 had its best start since 1998 while sovereign debt yields tumbled to the lowest levels in years and a much-watched portion of the U.S. yield curve inverted for the first time since before the last recession. In theory, it makes sense to think that “something has to give.”

That conclusion misses the final point I made in analyzing the global debt burden: That central-bank meddling will most likely become a permanent fixture of 21st century financial markets. Or, as Bloomberg News’s Ye Xie put it more recently: The Fed has put a ceiling on bond yields and a floor under the S&P 500.

Can Stocks and Bonds Both Be Right? Actually, Yes

Perhaps because the world has reverted back to low (or negative) yields, the massive global debt overhang is receiving another round of attention. But it shouldn’t come as a surprise that nonfinancial corporations ramped up borrowing during a decade of record-low interest rates. Any number of articles have highlighted the rapid growth in leveraged loans and the surge in companies with ratings just barely above junk. Likewise, it’s obvious that governments are running enormous budget deficits now and thinking about repercussions later. Thus, Modern Monetary Theory has risen to justify politicians spending beyond their means, even when times are good.

So in case it wasn’t clear before, there’s a lot of debt out there, and the main culprits are a combination of developed-market governments, nonfinancial corporations and China. What does this mean going forward? My Bloomberg Opinion colleague Robert Burgess has a theory:

In 2012, Carmen Reinhart, Vincent Reinhart and Kenneth Rogoff wrote in a paper published on the National Bureau of Economic Research’s website that economies with high debt potentially face “massive” losses of output lasting more than a decade, even if interest rates remain low. Could that be happening now? … Total debt in the U.S. grew by $2.9 trillion to more than $68 trillion in the largest annual increase since 2007.

For the U.S. government, debt is now about 100 percent of gross domestic product. Interest payments make up a large portion of the nation’s expenses, and it would be higher if the Fed didn’t keep rates low for an extended period after the financial crisis. Companies might be going on something of a “debt diet” while markets are favorable, but the Trump administration has shown no appetite for such belt-tightening. Borrowing from the future to spend today doesn’t exactly portend strong economic growth in the years to come.

This trend is one of the cornerstones for bond bulls like Steven Major at HSBC Holdings Plc and Lacy Hunt at Hoisington Investment Management. Major recently dropped his year-end forecast for 10-year Treasury yields by 40 basis points to 2.1 percent, which is lowest among 59 analysts surveyed by Bloomberg.

Hunt helps oversee the Wasatch-Hoisington U.S. Treasury Fund, which basically invests only in long-term Treasury bonds. It has beaten 96 percent of its peers in 2019, and 98 percent over the past five years, Bloomberg data show. “The secular low in long-term Treasury bond yields is well ahead of us,” he said, “it’s not behind us.” The past several months support this view. While 10-year Treasury yields remain more than 100 basis points above their all-time lows, 10-year bunds came within 10 basis points of a new record.

At this point, leverage is widespread and not going anywhere. It simply can’t — not without a severe growth shock. Elected officials aren’t about to stand idly by and let that happen. Neither are central bankers. If the idea of unwinding monetary easing was “positively quaint” seven months ago, it looks like little more than a pipe dream now.

For better or worse, that means stocks and bonds are both right to rally. At least for the time being.

Most forecasts are through March 14, while Major's call was as of March 29. It's possible others estimates will be lower when Bloomberg updates them later this month.

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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