Listen, SocGen’s Albert Edwards “wasn’t going to write this week”, but the bond market forced his pen, dammit.
As you’re probably aware, yields are on the rise and there’s talk that the reflation narrative is alive again. After a moribund quarter, 10Y yields have moved sharply higher against a backdrop of stretched short positioning (so much for that short squeeze) and that’s got Albert’s interest piqued.
Edwards begins by citing himself. Specifically, he starts his Thursday missive with the same devil’s advocate bond bear call that he used as a header in his Global Strategy Weekly note from June 13, 2007. Here it is:
As the bond rout continues, the biggest call investors have to make is whether the break of the multi-decade downtrend marks the end of the secular bull market. This is the big one. Get on the wrong side of a new multi-year bear market in government bonds and all investment portfolios will be shredded to ribbons, as bonds are the cornerstone of most equity valuation models.
Followers of Albert’s work can probably see where this is going. The title of today’s note is: “Is the Ice Age over? (or is this just déjà vu all over again)?”
“The rout in the bond market back then was even more savage than it has been in recent weeks, with the 10y yield rising from 4¾% in mid-May 2007 to the 5¼% peak on 12 June, 2007 just one day before I wrote the words above, pondering the possible end of the secular bull market for Government bonds”, Edwards writes, taking a trip down memory lane before noting that the technical break in June 2007 did not in fact presage the end of the bond bull market. Here’s Albert with a history lesson:
As Q3 progressed yields slumped towards 4% as the market began to sniff the recessionary vapours in the air (see chart below). Equities ignored the signs of course, and made new highs in October 07 a few weeks after the Feds first rate cut.
But by December, less than 6 months after the June peak in yields, the US economy had entered the very worst of recessions. Might history repeat itself?
It might! Who knows.
What we do know is that the recent move higher in yields comes despite the record spec short in the 10Y, extreme positioning which the likes of Jeff Gundlach have variously suggested could presage an epic short squeeze.
So much for the whole “spec positioning is a contrarian indicator” thesis.
In case you were wondering, Jeff is going to go ahead and act like he never suggested such a thing.
Yields: On the march! 10’s above 3% again, this time without financial media concern. Watch 3.25% on 30’s. Two closes above = game changer.
— Jeffrey Gundlach (@TruthGundlach) September 19, 2018
For his part, Edwards goes on to note that real yields are rising and that bodes ill for equities (more on that here). He also flags the risk of a February repeat thanks to signs of robust wage growth. Remember, the August jobs report featured a hot average hourly earnings print that tipped the swiftest pace of wage growth since 2009.
In case you have a short memory (or in case, like me, years of drowning the synapses in Balvenie makes it hard to remember what happened last week, let alone what happened six months ago), it was the above-consensus AHE print that accompanied the January jobs report which sent stocks tumbling on Friday, February 2, setting the stage for “Black Monday” and the VIX quake on Monday, February 5.
On that note, we’ll leave you with one last quote from Albert:
We have been here before: in early February similarly strong wage data spiked bond yields higher causing a temporary slump in equities (see chart below). So while we ponder whether the bond bull market is really over (which I doubt… at least yet), the more immediate concern should be what level of bond yields will trigger an equity market slump and whether against all expectations a recession might only be six months away just as it was in June 2007.