Bonds spoiled what should’ve been a rousing rally on Wall Street Thursday.
Markets were handed a Goldilocks GDP report featuring a headline beat, a “just right” personal spending print (more robust than consensus, but a sharp slowdown from Q1’s unsustainable pace), a solid read on capex and cooler-than-expected price gauges.
But between the upbeat US growth assessment, another downside surprise from jobless claims, the first increase in pending home sales since February and a Nikkei report suggesting the Bank of Japan will discuss a higher ceiling for JGB yields, Treasurys were compelled to sell off. That undercut equities.
“Under the more flexible policy being considered, the BoJ would permit gradual increases above the 0.5% threshold, but still clamp down on any sudden spikes,” Nikkei reported, adding that “even with more flexible yield-curve control, the risk would remain that rates could rise more than the BoJ intends, forcing it to step in with big JGB purchases.”
10-year US yields reclaimed a four-handle in a belly-led selloff that bear-steepened the 2s10s. At one point, 10-year yields were 16bps higher, and 30-year yields came very close to YTD highs. The move in 10s was among the largest of 2023.
“A solid real GDP print defined by moderating price pressures along with robust consumption combined with another drop in jobless claims and strong durables to push yields higher in a selloff that was also fueled by speculation of a policy shift from the BoJ,” BMO’s Ben Jeffery and Ian Lyngen remarked. “While we won’t question the reaction to the new information, the outright level of rates is now high enough that we expect buyers will begin to emerge, to say nothing of month- end that is quickly approaching and the duration needs associated with the conclusion of July.”
The domestic side of Thursday’s bond selloff was, to be direct, precisely what I warned about on Wednesday evening. The “Goldilocks euphoria,” I cautioned+, was “masking” the right-tail risk associated with an economic re-acceleration in the US.
Note also that early dollar weakness gave way to strength as the market digested the data and the language around the ECB hike. Christine Lagarde “switched off the autopilot,” as ING put it, describing the bank’s decision not to pre-commit to another increase in September. The euro plunged.
Ultimately, Thursday’s session underscored the risk from surging yields to an equity rally built entirely on multiple expansion and big gains for long-duration mega-caps, which are especially vulnerable to higher rates (even though, as one astute reader observed, Thursday’s relative performance within equities didn’t neatly fit that narrative).
The about-face for the dollar was another reminder that at a time when the US economy stands as the unquestioned outperformer, greenback weakness may be difficult to sustain. If the world is a friendlier place when the dollar’s weaker (and it generally is), the opposite is true when it’s stronger.
Today’s data — along with steadily rising crude prices — argues for moving up the timing of the next 25bps hike, to September, and opens the door (even if only a little) to an additional 25bps increase in November. Good for retirees, savers, and institutional investors. Not so good for banks, CRE lenders, and the fast-money crowd.
Interesting to see what out/underperf’d in the pullback. QQQ SPY (growth, large) better than MDY DVY IWM (cyclical, small, income), XLC and XLK (growth) better than XLRE XLU (income).
Yeah, that’s a good point. Thursday wasn’t neat and tidy for narratives.
Market rotation – rapid and exhausting. Contrast R1000G to R2000V, these being at opposite ends of the large-small and growth-value spectrum. R2000V outperf’d Oct to Dec, R1000G outperf’d Mar to Jun, R2000V outperf’ing now . . .
No shortage of macro market narratives. For example, if you believe the near-recession is over and economy is back in expansion, then you’d favor small and cyclical (value). If you believe recession is merely delayed to 1H24, then you’d favor large and growth.
At industry level, various cyclical inflections one can point at. Semis and semicaps are reporting less-bad quarters and guiding for 2H improvement, so that cyclical trough is maybe in rearview mirror. The freight recession is in full cry, so that cyclical trough is maybe here. Banks seem to have gotten through the immediate existential risk, so maybe we’re somewhere in that cyclical troughing process. Etc etc.
At the end of the day:
The recession-bears lost, they have to find a new stance, even if only for a couple of quarters.
FOMC is fading as a market force, as long as inflation looks on a path to reach 2% sometime in 2025, that’s up to two years away so not a “high bar” right now.
Market has absorbed Treasury’s bill issuance just fine, now we see if it will absorb Treasury’s bond issuance.
Valuation on forward P/E is somewhere in the ambiguous zone – as discussed elsewhere, downcap is 14X and up-cap ex-Magnificent Seven is 17X, and for The Seven, just say “AI” seven times fast. I haven’t refreshed my index DCFs lately.
So far this 2Q reporting season, percentage of earnings beats is positive – not sure where estimate revisions are shaking out but stocks are acting like its ok.
Sure, some macro charts look pre-recessionary but most active relative managers have 5 months left to salvage 2023.
Federal debt service cost is soaring, but in the can-kicking spirit, investors seem to have agreed to not care.
Bottom-line – its not just the Fed that has gone to “data dependent” reactive behavior.
Yep. Interesting but not surprising in a way. On Wednesday night I was chattering with another older equity manager. He was lamenting how we finally were seeing small caps, industrials and such in recent weeks. (Lamenting because it was running over dome shorts he had been running.)
Suddenly it was obvious: those were the stocks that the last holdouts were buying as FOMO became overwhelming. “I gotta buy something but I’m not gonna pay up for Nvidia or even more Apple. I’ll wave in some of the laggards instead.”
It worked for a couple of weeks before the quarter end and into this month.
The problem is that those were low conviction buyers who were ready to change course at the first sign of trouble. Perhaps that explains some of the moves JL refers to?
I basically was front running that trade back from June till now. The June portfolio.-1.5% today. Still +4.5, so for the time being hold. US Economy is a rising tide. China has to piss or get off the pot.
I bought some small transportation cyclicals in mid 2022 (EXPD CHRW RUSHA), held them nervously, and cut them in 2Q when my gains became long-term, because, well, economy slowing etc. I kick myself every day now. My humility cup runneth over.
Aint that somethin? The buddy I was talking to was SHORT trucking stocks. All beyond me…
Oh, short truckers is not what you want to be now (in my opinion).
Deep cyclical stocks, turn down when things are great and turn up when things are terrible.
(Speaking as the village idiot who exited his small cap transport names way too early and thus feels your buddy’s pain.)
I did the same thing (probably much smaller $$) with individual stocks. Sold them way too soon. You can kick me too.