What Do Falling Bond Yields Mean for Stocks

Record heat.  Stocks rose to new highs on economic optimism. Flash PMIs indicated a beat in manufacturing and a miss in services, which continued to trail in the recovery.

N O T E W O R T H Y

Not gone, but forgotten.  We knew this wasn’t going to be easy. Human nature, unless one is clinically pessimistic, is to attempt to justify and put down worries in order to continue to forge on.  I have to admit that I, myself, felt a sense of relief at the onset of summer.  Virus numbers were down, vaccination rates were up, and restrictions were being lifted.  I was happy to be able to smile at the Whole Foods cashiers that I see every day on my way home from the office.  Never mind the sense of freedom of not having to wear a mask in every store I walked into.  It would have been really easy to simply assume that the pandemic was over and a new world was about to emerge like a fiery phoenix from the ashes of COVID.  The markets, for the most part, have labeled the pandemic “a thing of the past.”  The new worry was inflation induced by the economic surge that was underway in the post-lockdown economy.  Even the optimistic and sympathetic Fed has begun to show its concern over persistent inflation, which has many investors expecting it to cut back on bond purchases and raise key interest rates earlier than expected.  

The facts do support this scenario.  Economic numbers are looking good, inflation figures continue to be on the rise, and consumer sentiment remains positive.  Why then are those pesky bond traders pushing longer maturity treasury yields lower when the prescription for the above scenario is to sell bonds causing yields to rise?  The answer is simple.  Bond traders believe that the economy may not be on such stable footing as we would all hope.  Perhaps they are referring to inflation numbers that continue to rise, or maybe, they are focused on the improving-but-not-by-huge-amounts unemployment.  Unemployment is one of those numbers that is bucking the improving economy trend.  While the unemployment rate has been ticking lower, it remains higher than one would expect.  Just think about your hometown Main Street. Remember what it was like to go to a store or a restaurant in late fall, then compare it to now.  I was at a family brunch this past weekend and I am pretty sure that the eatery was far above capacity while just 6 months ago it was park benches in the parking lot and take-out mostly.  Surely this would require more workers, which would theoretically re-employ sidelined service workers, causing the unemployment rate to dip drastically.  Nope, the numbers don’t support it, which means that companies may be facing labor supply shortages… which can become an economic growth killer.  Worse yet, perhaps bond traders have pulled up the COVID infection / hospitalization rates and noticed the quite obvious uptick that has occurred since Independence Day.  That worry has always been below the surface for stocks and it reemerged last Monday as stocks experienced a blistering rout.  The selloff, however didn’t stick and stocks rallied to new highs by last Friday’s close.  So, stock traders have clearly attempted to push down COVID fears and refocus on the reopening trade, yet bond traders continue to prepare for another possible economic quagmire.  Who is correct and what should we be watching for?

A difference in opinion between the stock market and the bond market doesn’t often occur but it is not altogether uncommon.  The problem with those disagreements is that when they are resolved, one party usually ends up feeling some pain.  A worst case scenario would include the COVID delta variant causing a significant enough resurgence to justify another fall-2020-style lockdown, which would crown the bond market the winner of the debate.  The loser, stocks, would surely feel that pain. Before we get all panicky, let’s remember that the economic slump of 2020 was caused by lockdowns and not masks or even the virus itself.  So, the question we should be asking ourselves is whether we can expect a draconian, country-wide lockdown once again.  That answer will likely be up to lawmakers, so it is their body language, and er… their actual language that we need to focus on in the weeks, and possibly months ahead.  While the stock market has managed to dismiss this recent surge in virus cases, we need to remain unemotionally vigilant in our diligence.  At this point I don’t think any of us is expecting to go back to takeout-only dining, but many of us are getting in those smiles to the cashiers just in case those pesky masks make a comeback.  Stay healthy, stay focused.

THE MARKETS

Major stock indexes soared to new all-time highs on Friday and pure economic optimism.  The S&P500 rose by +1.01%, the Dow Jones Industrial Average climbed by +0.68%, the Nasdaq Composite Index traded up by +1.04%, and the Russell 2000 Index added +0.46%.  Bonds slipped and 10-year treasury yields were flat at 1.27%.  Cryptos were off slightly by -0.25% but surged over the weekend by +17.07% after Amazon posted a job opening for a Head of Digital Currencies leaving crypto traders believing that the retailing giant has some crypto plans of its own.

NXT UP

– New Home Sales (June) is expected to have risen by +3.7% after falling by -5.9% in May.

– Dallas Fed Manufacturing Activity (July) may have increased to 31.6 from 31.1.

– This morning, Otis beat expectations and we will hear from Lockheed Martin before the opening bell, while F5 Networks, Cadence Design Systems, and Tesla will report after the closing bell.

– This week will include lots of earnings releases along with housing numbers, regional Fed reports, Consumer Confidence, GDP, PCE deflators, Personal Consumption, and University of Michigan Sentiment.  The Fed will hold its FOMC meeting tomorrow and Wednesday and hold a press conference.  Traders will want to hear about the ongoing rate debate along with a bond purchasing taper schedule. Please refer to the attached economics and earnings calendars for details.

IMPORTANT DISCLOSURES.

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