While the stock market garners most of the headlines in the financial media, the bond market has put in an amazing performance in the past three months. On November 8th, the yield on the benchmark 10-Year U.S. Treasury note hit 3.24%, its highest level since April 2011. With that 7.5-year high came the usual torrent of predictions from pundits of a continued "backup in rates." Boy, were they wrong. Today the 10-year yield sits at 2.63%.
The 10-year hasn't traded above 4% since September and October of 2008, and we all know what happened then. That was actually a much lower level than had prevailed in 2006 and 2007 though, and, in hindsight, the bond market's boom in late 2007 and early 2008 was a harbinger of a crash in the global financial system.
A shift from stocks to bonds is a classic example of a risk-off trade, and traders who took risk off the table in early 2008 were handsomely rewarded with relative outperformance versus the soon-to-crash global stock markets.
So, I have to ask myself the question: are we seeing the same phenomenon now? Certainly 12 years is a long enough time period to fool the algorithmic traders and their formulas, which have really been honed in this market cycle, as technology was not as developed in prior ones. Is this dramatic move lower in global interest rates -- the yield in the Japanese 10-year government bond has gone negative again, and with a yield of 0.11% Germany's 10-year Bund is threatening to do so -- a sign of a coming crash in global equity markets?
Crashes occur after booms, and the market's sharp selloff in the fourth quarter may have just been a reaction to the ridiculous valuation afforded to the megacap tech titans during the summer. If you bought Apple (AAPL) at $232 on October 3rd -- I am sorry to say it -- you made a horrible trade. Similarly, if that same week you purchased Amazon (AMZN) shares for over $2,000, the flaws in your trading strategy have been exposed even more than the details of Jeff Bezos' personal life.
So, that's the conundrum facing the markets. The stock market roared back to life in January, with the S&P 500 posting a 7.9% gain for the month after December's 9.6% plunge, but the bond market did not show any evidence of a shift away from risk-free assets. According to the St. Louis Fed's FRED data, the yield on the 10-year was 2.69% on December 31st and 2.63% on January 31st. If there had been a true change in the market's conviction on the risk-reward for U.S. equities, bonds would have sold off during January's equity rally and the yield would have moved back through 3%. The opposite occurred, and thus I have to label January's move as a "sucker's rally."
Suckers rallies should be sold off by active traders, but for long-term investors that sort of trading is not advisable. You should only be engaging in wholesale divestment of your equity holdings if the bond market's rally and the selloff of the past two days have convinced you of a coming crash. Please immediately delete any emails in your inbox from charlatans referring to secret pipelines or other such doomsday hoaxes. Watch the value of real assets.
So, without a crystal ball, or an accurate one, anyway, I have been looking at the value of my least favorite hard asset this week as predictor of stock market performance for 2019. On August 15th, 2018 gold was fixed in London at $1,181 per troy ounce in afternoon trading and today's fixing was at $1,313. That move, frankly, scares the bejesus out of me.
Gold's true value is as a hedge against inflation. Yet Fed Chair Jerome Powell and his counterparts at other global central banks seem to be huge fans of Hogan's Heroes and Sergeant Schultz: when it comes to inflation they keep saying "I see nothing!!!!!"
So, if there's no inflation anywhere, why have gold prices rallied 11% in six months? The smart money is scared now, and that fear is quite evident in the trading level for government bonds and precious metals. Stock market investors always seem to be the last to know, but if you don't want to lose your capital you should leave that group.