Market Talk

For most of this year, while the stock market’s been flopping around like a fish, the bond market has been steadily rising, with bond yields steadily falling. It’s hard to say exactly how much of this is due to investors seeking the safety of bonds and how much is due to the Federal Reserve consciously keeping yields low. Suffice it to say that while investors have been dumping stocks, look at mutual fund flows, the sell-side on Wall Street, those “bulls” who somehow always are somewhere telling you now’s the best time to buy stocks, have been crying that bonds are in a bubble, and that bubble is bound to burst.

It’s quite amazing that this crowd, which didn’t see any bubble in stocks in 2000, which didn’t see any bubble in housing or stocks in 2007, somehow suddenly has crystal clarity on the subject. They don’t. They’ve just been in stocks for so long, they can’t conceive of a time when stocks wouldn’t be the best investment around.

I read the best rebuttal to this argument I’ve yet to see this morning (albeit David Rosenberg has also been banging this drum loudly and convincingly) from Capital Economics’ Julian Jessop. Pay particular attention to his first line, because that sums it up in a nutshell.

An asset bubble develops when prices move far out of line with anything that could reasonably be justified by fundamentals. That was the case with dot.com stocks in 2000 and many property markets since. However, the current low levels of bond yields (and even further falls) would be consistent with the prospect of a very long period of near-zero short-term interest rates, low or negative inflation, and lacklustre returns on riskier assets that increase demand for the safety of government bonds. After all, these factors have kept Japanese government bond (JGB) yields very low for many years – much lower than the levels currently seen in the US and Europe – despite the dire fiscal position in Japan.

Admittedly, structural factors have also played a key part in driving down JGB yields, including a large pool of captive domestic buyers. But similar factors may come increasingly into play in the US and Europe too, as changing regulatory requirements and additional QE prompt both private institutions and central banks  to hold more government bonds on their balance sheets.

The upshot is that we see no compelling reason why bond yields cannot fall further in the US and Europe from their current levels, without this amounting to a bubble.

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US stocks looking at a notably weak opening, after the 1o-year Treasury yield fell under 3%, and as stocks get clobbered overseas, with citations going to the general “fears over global growth,” and China in particular this time.

Shanghai Composite down more than 4% to a 14-month low. The euro has slid below $1.22, dollar boosted, oil retreating sharply and gold down slightly. Main European stock markets each currently down about 2%.

If economic growth is indeed the big concern these days, investors have gauntlet of data to run between now and Friday morning, with June ISM (Thursday) and nonfarm payrolls (Friday) likely being the most influential. April Case-Shiller home price index due at 9:00 a.m. ET, and Conference Board’s June gauge on consumer confidence set for 10:00 a.m.

S&P futures down 15.30; Dow futures off 129. Ten-year note adds to yesterday’s gains, yield at 2.98%.

Gluskin Sheff chief economist David Rosenberg highlights some of the major differences in the equity markets throughout the last year. (Registration required.)

• The VIX was 50, not 17.
• The yield on the 10-year Treasury note was 2.9%, not 3.7%.
• The budget deficit was $900 billion, not $1.5 trillion.
• Baa spreads were 540bps and tightening, not 260bps and widening.
• The market was 20% ‘cheap’ as per Shiller P/E ratio, not 25% overvalued.
• The DXY was at 90 and depreciating, not 80 and appreciating.
• Oil was at $47/bbl, not $82/bbl (we can see $80+ crude being good for the Saudi market; we’re not sure how it fits in bullishly to the S&P call).
• Equity PM cash ratios were at 5.5%, not 3.6%.

The only thing we’d like to add is some jobs data. Unemployment rate has soared from 8.1% in February 2009 to 9.7% last month. But 651,000 jobs were lost in February 2009, compared to only 36,000 last month.

What did we say this morning? That little itch should be telling you something.

Stocks get clipped as equities investors watch the carnage over in the bond market, where the 10-year yield rocketed above 3.70% (we saw it as high as 3.717%), and as GM steers itself toward bankruptcy.

DJIA drops 173 (2.1%) to 8300 (actually 8300.02,) S&P 500 loses 17 (1.9%) to 893 (itself a key support level,) Nasdaq Comp slides 19 (1.1%) to 1731. Big Board volume’s light; comes in around 5.4B shares in composite volume; average volume this year is around 6.3B.

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