There may be tiny bubbles but this is not the year 2000.
“On the Road Again” I can’t get this great Willie Nelson song out of my mind, with my first travel on business this year to gorgeous Pinehurst, N.C., for one of my favorite annual events (10th year!). I can report that the plane was overbooked and completely full. “Life, my love, is talking markets with my friends, oh, I can’t wait to get on the road again ….” OK, concentrate! Stocks wobbled this week as long yields jumped—the 10-year Treasury briefly topped 1.60% on Thursday, up 25 basis points in less than a day. It eased off to settle at 1.53%, still its highest level in a year, and as of this writing, was bouncing around 1.43%. This week’s developments in the bond market certainly felt disorderly—the bond VIX spiked and the 30-week rate of change soared to its second-highest level ever. If there’s a bubble anywhere, it’s in government bonds—witness $18 trillion of negative-yielding bonds around the world. The Fed continues to buy $120 billion of bonds monthly with no end in sight, even amid a recovery that forecasters predict will be the best year for GDP since 1984. What yield on the 10-year causes trouble for stocks is the question du jour. Wall Street estimates are all over the map, though none believe it's an issue until it reaches 2%. Term premiums (the yield investors require to lend long) have been rising since last March with inflation expectations, thus real rates remain negative. Rising real rates, not nominal ones, tend to be a problem for equities. But they’re still negative!
While the bond sell-off may be overdone, the bias on long yields is up. The economy is reopening and momentum is strong—so strong that JP Morgan’s chief economist believes our V-shaped recovery will soon surpass China’s. The yield curve is still well below neutral (when rates neither support nor inhibit growth); that tends to occur at the peak of Fed cycles. Clearly not the case now. Meanwhile, demographics and the rise of artificial intelligence represent deflationary forces in their early stages. With real yields negative and the earnings outlook strengthening, the fundamental case for stocks remains bullish. Credit Suisse notes that equities don’t tend to re-rate until inflation is above 3%—it’s still below the Fed’s 2% target, where it’s languished for decades (more below). A period of higher inflation is not impossible as deflationary forces abate, economies accelerate and the velocity of money picks up. Even with the massive fiscal and monetary stimulus, this has not happened to date, with an historically high 13% savings rate. However, House Dems are set to pass another $1.9 trillion Covid relief bill. Our Washington research suspects a final passage will be close to that figure. Might lots of that money go into stocks? So far, the stock market has only “tiny bubbles’’ …
… Game, will you please Stop! Clearly, so-called “meme stocks” are in a bubble, as prices for GameStop, AMC and other struggling companies hyped on Reddit soared again this week. People are wondering, who is buying? Novice investors? Everyone? Warren Buffett’s right-hand man, Charlie Munger, on CNBC said novice investors are getting lured into a bubble in “a dirty way” by Robinhood. Is this just a (now recurring) sideshow? We might find out when that next $1,400 stimulus check shows up in bank accounts. I was there in 2000 when the tech bubble burst. Back then, we weren’t counting earnings or revenues. We were counting eyeballs. Today, there is no evidence the broad equity market is in a bubble. Thankfully, no one is counting eyeballs. But are they counting hedge-fund targets to take down? Bubbles belong in a bath. With some lavender.
- Capex going strong Non-defense capital goods ex-aircraft orders, a key measure of business investment, rose again in January to a new high and December’s gain also was revised up. Over the last six months, core shipments have surged at an 18.3% annual rate. Overall, durable goods orders rose last month by the most in six months, and measures of manufacturing activity in Texas, Virginia and Chicago all rose this month, with Chicago’s its highest since July 2018.
- Here comes the consumer Consumer spending jumped in January by the most since June, aided by a new round of stimulus checks, an improving economy and a boatload of saving that’s set to get another shot with a new round of stimulus. The Conference Board’s consumer confidence gauge hit a 3-month high this month, indicating households are ready to pick up the pace as Covid fades and more and more businesses reopen. Michigan sentiment also improved.
- Housing holding up so far New home sales beat estimates, climbing to a 3-month high in January, and the prior three months were revised up as well. Home prices also continued to rise, up more than 10% on a year-over-year (y/y) basis, the fastest pace since December 2013, according to the Case-Shiller survey. It will be important to watch mortgage rates, which have behaved despite bond market volatility.
- The biggest thing holding back housing is supply Pending home sales declined by 2.8% in January, lowering the y/y sales rate to a still very strong 8.2%. Weather and rising mortgage rates played a role, but slim inventories remain the biggest drawback for buyers.
- Everyone’s watching inflation The Fed’s key measure, the PCE price index, continued its climb in January and has now risen to 1.5% y/y, inching closer to the Fed’s 2% target.
- Tiny bubbles Google trends mentions of “stock market bubble” have moved sharply higher and Credit Suisse’s measure of exuberance (the number of companies with price-to-sales greater than 10x whose share price has more than doubled in three months) is the highest since 2000. That said, this measure is only about half its dot-com peak.
Investors should care about inflation All excess returns from owning U.S. equities in the last 142 years came in disinflationary periods, Gavekal Research shares.
Remember “The Death of Equities”? The infamous BusinessWeek cover story in 1979 preceded one of the strongest secular bull markets ever. This comes to mind as a headline on the front page on the Wall Street Journal this week said “Travel’s Covid-19 Blues Are Likely Here to Stay — ‘People Will Go Out of Business.’’’ So, what happened in the markets that day? Travel-sensitive names surged.
Disturbing correlation Crime rates went through the roof in the 1960s, a decade of rising political and social unrest. Early estimates suggest that 2020, which was similarly marked by political and social upheaval, saw the homicide rate jump 37%, an inauspicious start to a new decade.