Ignore The Bond Guys, They're Always Gloomy
Every financial market has an image amongst the denizens of other markets. Everybody looks down on everybody else. The interbank forex market, where I made my living, is regarded by others as being full of low class, hyper-aggressive, low-brow jerks. Currency guys in turn look down on everybody else, confident in the knowledge that it is they, not the self-important stock traders, who really control the fate of nations. There is one thing that all other markets agree on. Bond traders are boring, somewhat depressing, conservative types who are scared of their own shadow.
Of course these internal prejudices among traders are repeated with tongue firmly implanted in cheek, and, like all stereotypes, when analyzed, are clearly nonsense. They do, however, stem from the nature of the markets themselves. Foreign exchange was always, even in the pre-computer days, fast paced. During busy periods it wasn’t unusual for a broker such as me to trade 10-12 times a minute. There wasn’t time for careful consideration, hence the market’s reputation for shallow, unintelligent types. Bond traders were regarded as boring and fearful because the market attracted money from investors who liked boring, or who were scared.
In that environment, scared is good. Remember that the next time you hear a bond trader interpreting every piece of economic data as an indicator of disaster just around the corner. That talking head on CNBC, Fox Business News or Bloomberg is not cynically exploiting the fact that fear sells, he or she just can’t help it; they are predisposed to look for doom and gloom in everything. In fact their livelihood depends on it.
Little wonder, then, that as US Treasury yields have continued to fall, even as the stock market has hit record highs, there has been no shortage of doom mongers. Some are blinded by politics; their partisan selves just know that there cannot be economic success with a Democrat in the White House. History would suggest otherwise; the US economy is a remarkably resilient, independent thing that marches to its own non-partisan beat. Some don’t even have that excuse, they’re just bond guys. Whatever the reason, they have been wrong for the last 3 years and nothing has changed.
In years gone by I would have said that they had a point. Capital was traditionally allocated between bonds and stocks based on economic outlook. Low bond yields (meaning higher prices) meant that capital was seeking safety. Insiders knew that, contrary to popular opinion, the bond market always led the stock market. If the stock market rose as bond yields fell, it was the stock market that would correct. As the last few years have shown, though, that is no longer the case.
Stocks have continued to march upward, while Treasury yields have stayed depressed. Neither thing has been in a straight line of course, but we have the S&P at record highs and a 10 Year Us Treasury Note that yields somewhere around 2.5%. According to the old conventional wisdom that shouldn’t be possible.
The reason, as I have said before, is that the world is awash with capital. Even as the Fed exits from QE the ECB and Japan continue to boost liquidity. Even the Fed still has no real timetable for the normalization of interest rates. The Central Bankers, it seems are intent on distorting markets. The net result is a giant pool of cash chasing returns; plenty enough to keep stock prices rising and Treasury yields falling.
Logic tells us that at some point, something has to give, but as long as these conditions persist it is foolish to bet on that. If a problem is to emerge, then I believe it is most likely to come from Europe, and will play out in bonds. The recent EU elections gave clues as to the level of political discontent, with anti-EU parties doing better than expected everywhere. That is hardly surprising when countries such as Spain are looking at a chronic unemployment problem, but the fact that liquidity pressure has resulted in a 2.87% yield on the Spanish 10 year would indicate that this time it is the sovereign bond market, not the stock market that is vulnerable.
At some point, those scared noises coming from bond traders and analysts will be justified. It is in the cyclical nature of markets that they will, and European sovereign bonds could well be the catalyst. For now though, investors should close their ears to what the naturally gloomy bond guys are saying. Low Treasury yields are a product of the conditions that keep stocks buoyant, not an indicator that disaster is just around the corner.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.