Interest rates are the heart, soul, and life of the free enterprise system.
-- Michael E.S. Gayed
I fail to understand why no one is getting more concerned about the way bond yields have behaved in the past few months. For some time now
, I have warned that spiking interest rates are not
a good thing for the economy and for the stock market. While historically one can point to rising rates as desirable for equities, the rate of rising rates is almost always ignored. So let me make this as clear as I can: Rising rates are good if gradual, and if it is a reflection of demand for money (inflationary). However, if rates spike, it serves as a shock (deflationary).
It is for this reason that I have in the last few days argued that there are parallels to 1987 here in 2013. In 1987, yields spiked and the Dow Jones Industrial Average
(INDEXDJX:.DJI) was on a tear. The Crash of 1987 was a coiled response to the bond market shock as investors, after a lag, panicked. History never exactly repeats, but it is instructive to consider fragility in US averages when bonds act violently and stocks have a delayed reaction. Interest rates are what differentiate capitalism from communism. Interest rates are what drive risk taking. If you want to cause an instant depression, raise rates overnight to 25%. If you want a massive boom, lower rates to -25%. You'll get Dow 100,000 alright, but of course, that comes at the expense of inflation.
So what does this imply about “Sep-taper?” First, I find it hard to believe that the Fed will get too aggressive on any kind of reduction of stimulus. The Fed does not dictate policy – the market does. In a world where the multiplier is broken, market cap volatility can erase the benefits of any kind of “wealth effect” for stocks. Any kind of violent reaction that may be in the midst of happening would be a warning shot to the Fed. From an investment implications standpoint, that means we may see the bond market soon recover as stocks scare Super Ben and the League of Extraordinary Bankers into action.
Take a look below at the price ratio of the iShares Barclays 20+ Year ETF
(NYSEARCA:TLT) relative to the SPDR S&P 500 ETF Trust
(NYSEARCA:SPY). As a reminder, a rising price ratio means the numerator/TLT is outperforming (up more/down less) the denominator/SPY. A falling ratio means the opposite.
Yes – stocks are still outperforming bonds, and that trend has been in place since mid-November of last year. However, I suspect a support line may soon form as bonds begin potentially outperforming stocks. Why? Because if the market is able to sufficiently scare the Fed, then yields fall again, which in turn would make stock investors question just how strong the economy is after all.
I got your taper right here
No positions in stocks mentioned.
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