It’s the latest chapter of the ever-raging battle between stocks and bonds.
Treasury yields signal a brewing economic slowdown while equity bulls are cheering the business cycle. The schism is testing the mettle of investors mulling whether to ride or fade the $3 trillion new-year U.S. stock rally.
The S&P 500 is on track for the best two-month run since 2010, fueled by the most economically sensitive sectors, even as 10-year U.S. Treasury yields hover close to the lows plumbed during the recent global market meltdown.
Growth angst is feeding haven demand for longer-dated debt, while the U.S. futures market prices in interest-rate cuts. In Europe, benchmark bund yields are trading close to the lowest in more than two years, at the same time that equities have climbed near a four-month high.
It’s all adding to fears that the fast re-rating of stocks after the overwrought correction in 2018 has gone too far.
“Investors are getting a little bit ahead of themselves,” said Simon Wiersma, Amsterdam-based investment manager at ING Bank NV’s wealth management unit. “There’s a lot of optimism, but that could turn quite soon if economic figures are not better than they are right now.”
Dovish monetary signals in the U.S. and Europe have spurred a rush to risk even as Nobel laureates to corporate chief financial officers fret the prospect of a contraction. Cyclical sectors have rebounded against defensives, while more volatile and leveraged shares have regained favor -- in concert with a spirited rally in risky corporate bonds.
The stock “market has been pushed higher by hope rather than actual improvement in the economic outlook,” Ned Davis Research analysts Tim Hayes and Anoop Nath wrote in a note. “Among the signs of deficient fundamental support is the lack of rising bond yields.”
Low bond yields threaten the usual suspects like financials and, to a lesser degree, industrials and energy given their typically stronger relationship with interest-rate markets, according to the strategists. Yet, these sectors have rallied at least in line with the S&P 500 this year.
The most sanguine explanation is that shares are still coasting on cheaper valuations and a Goldilocks economy that’s cool enough to justify a dovish Federal Reserve but warm enough to support earnings. Add signs of progress in U.S.-China trade talks, and you have a case to be bullish.
But it all sits awkwardly with the Wall Street maxim that the smart money in Treasuries is a lead indicator for the cycle -- and the disconnect looks extreme.
The S&P has jumped more than 10 percent since the U.S. central bank chief Jerome Powell said early January that the Fed will be “patient” with the tightening trajectory. That compares with an average 11 percent six-month return fed by monetary pauses historically, according to Credit Suisse Group AG.
U.S. cyclicals also appear to be pricing in a stronger economic growth outlook than supported by the data -- one reason the bank’s strategists led by Andrew Garthwaite downgraded the asset class to neutral this week.
Over at KBC Asset Management NV, which oversees about 100 billion euros ($113 billion), Dirk Thiels has also shifted to neutral on equities in the wake of the gravity-defying bull advance.
“Some of the rally is a bit of a correction for the exaggerated moves we saw in December,” the head of investment management said from Brussels. “But basically it’s a bit worrying when the economic signs are worsening and the stock markets are rallying.”
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