Corrections, Whipsaws And A Half-Century Of ‘Precedent’

Corrections, Whipsaws And A Half-Century Of ‘Precedent’

US investors were looking for signs on Tuesday that the relentless, grinding rout in tech shares was set to ebb, after the Nasdaq 100 officially fell into correction territory. They weren’t disappointed. Tech surged.

The dollar was lower and Treasurys rallied, setting the stage for buoyant risk sentiment, but with supply looming and nerves frayed, nothing is assured.

Global equities are understandably struggling to make sense of a world where the leadership baton is being passed to cyclical value. That handoff was never going to be smooth. European shares are poised to benefit, and that was on display Monday. But a bear market in Hong Kong tech underscored the perils of a world in which investors can no longer count on perennial winners to shoulder the burden. The swoon in mainland Chinese shares prompted state intervention Tuesday.

“The wild ride for the market’s mega-cap leadership and growth stocks continues,” JonesTrading’s Mike O’Rourke said, marveling at extreme oscillations in Nasdaq futs. “Despite the volatility, the Nasdaq 100 only declined 1.3% over [Friday and Monday],” he remarked. “Welcome to whipsaw world.”

Colloquially speaking, it’s “messy” out there, and speculation that more fiscal stimulus in the US will catalyze an inflation overshoot faster than the Fed can react adds to the uncertainty, as does the prospect of a stronger dollar on “higher” US real yields (the scare quotes are there to remind you that “higher” is a relative term — reals are still negative).

One fun exercise conjures a visual that suggests yields have a long way to go before catching up to GDP. Or at least if you go by forecasts.

A bit of creative extrapolation produces the figure (below). It takes the average of professional GDP forecasts, tacks on a projection for PCE, and then subtracts the current 10-year yield. This exercise (which Bloomberg conducted on Monday afternoon) produces a future gap between yields and nominal GDP growth of 6%. That would be the highest in five and a half decades.

The implication is that yields have room to run higher. Of course, because it’s based on forecasts, it’s inherently uncertain. It also assumes that historical relationships related to an economy that no longer exists somehow hold today.

Not only has the economy changed, but so has the way we think about bond yields. Government bonds are an administered asset. If central banks suppress yields while fiscal authorities inject stimulus, it’s pretty easy to imagine a large gap between nominal GDP growth and artificially suppressed bond yields.

And that underscores a larger point I’m fond of making. The world is constantly changing. A half-century is not a long time in the grand scheme of things. And there is nothing “natural” about the “laws” of man-made markets.

So, relationships like that shown in the figure may prove totally unreliable as guideposts going forward.

That said, the relationship has been steady over the QE years. If bond yields do, in fact, surge to “catch up” with nominal output, and if that happens despite central banks’ efforts to avert a disorderly bear steepener, market mavens of all sorts would say “I told you so.”

You can draw your own conclusions.


 

4 thoughts on “Corrections, Whipsaws And A Half-Century Of ‘Precedent’

  1. This will take fed-fighting to a whole new level of cage match: irresistible $1.9T force meets immovable Fed object. I won’t try to call the match, but I’d suggest equities win: an undue rate rise must jump twin hurdles of Fed’s unlimited policy ammo and the market’s certain pondering over the rate implications of post-stimulus “letdown”. That GDP/10yr spread will have a transitory peak. Yields may rise, but they’ll be getting increasingly nervous along the way.

  2. I like Jerome Powell, I’ve always liked Jerome Powell, even and/or because of his communication “issues.” He strikes me as a level-headed kind of guy with a lot of experience of the world who thinks the yield on the world’s benchmark bond should be higher than the rate of inflation — for a whole host of reasons, including the retrirements of tens of milions of boomers and the viability of all sorts of pension funds — and is willing to let rates rise, even if equities take a hit in the short term. Making a lot of assumptions there, obviously, but if that’s his view, I find it hard to fault.

  3. Two things to mention here… the first is the ‘rate of inflation’. If you’re referring to the ‘official government’s’ rate of inflation, my view is that it’s meaningless – for a whole host of reasons. It’s artificially set to give the government an excuse to not pay it’s debt at the real rate because it would have to delve deeply into MMT to come up with the money and it isn’t prepared to do that. Going shopping for the family’s food for the week or a new pair of shoes to replace those worn out one’s you’re so fond of or some lumber to build that fence you promised. Now you’re getting an idea of what the real rate is…
    The second point is that millions of working people were pushed very hard into making investments (with tax breaks to make it easier) so that they wouldn’t have to totally rely on that pension fund or government support programs when they retired. So, to have equities take a hit because the world’s benchmark bond fund isn’t keeping up with either the stated or real rate of inflation is like having to drag an anchor behind you while you strive to get ahead.

    1. Millions of working people were pushed very hard into making contributions to retirement plans/accounts (with tax breaks to make it easier). They were pushed equally hard to take responsibility for how those funds were invested – in fact I would argue that is the point (to shift risk away from corporate balance sheets and on to individual workers).

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