July 8, 2021
Good morning,
The following is a reprint of the cover letter included in client’s monthly performance reports going out this morning. I wrote this last night which makes it unusually suited for today’s Morning Note. To avoid burying the headline, to summarize what is below – bond investors appear to believe it’s not just inflation that is transitory.
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The month, quarter and first half of this year all wrapped up last week and on a positive note. For the month, June turned the common Wall Street trope – “Sell in May and Go Away” – on its ear, at least for this year.
Equities rose throughout Q2 as vaccination campaigns continued to accelerate in most developed economies, especially in Europe, which has been catching up with the UK and the US.For first half, we seemed to witness the bull market transition into the second year of its life-cycle displaying all the common traits of a 2nd yr. bull – more frequent pullbacks, higher volatility, and a flatter growth curve compared to Q121 and all of year 1.
The most common link to these three time periods is perhaps the most surprising as well. It’s been the extreme movements in interest rates – nominal and real – all year. In the first quarter, the Fed suffered a tidal wave of criticism with most investors in disbelief of their inflation-is-transitory argument. Their disbelief manifested in the U.S. 10yr Treasury yield rising to a high of 1.77% in March from only 90 basis points at the start of the year – that’s a quantum move in bond-land for those keeping score at home. However, the bond pros have seemingly had a change of heart. Maybe the Fed isn’t wrong, maybe they are not behind inflation and planning to raise rates (taper) too slowly. The 10yr treasury is yielding 1.31% as I type (7/7) – and that’s nominal, real yields are now at negative 1%. There’s no way of knowing today but I fear – as your fully invested Bear – that bond investors (typically the smartest guys in the room) now don’t just believe that inflation is transitory, I think they may be signaling that economic growth overall is very transitory.
This new behavior may not immediately translate into lower equity prices and it’s impossible to perfectly gauge the overwhelmingly bullish effects of seemingly endless liquidity in the market. However sooner or later that spigot will cease and the equity market may begin to care about why bond yields have suddenly fallen so much so fast.
I remain confident that the Tape will signal us when that time comes – I just believe it’s probably sooner than most equity market participants expect.
Be well,
Mike