Thoughts on rates, bull markets, bear markets, and QE
Mis à jour
Hey all,
I wanted to post a few thoughts of the somewhat educational variety. Hopefully this will help with perspective on where we've been and why I continue to see equity market weakness for the extended and foreseeable future (1-3 years maybe). So starting with this chart, this is the 10 year US Treasury yield below and the S&P 500 index above going back to approx. 1980. It's log scale to make each asset more meaningfully represented. What we notice about the 10 year yield relative to equities throughout this ENTIRE 40+ year period is that it has been on a steady declining slope as the S&P has seen significant growth and gains. The numbers for each over this stretch are as follows.
10 Yr Yield High: 16% (nearly) in Sep '81
10 Yr Yield Low: .33% in March '20
S&P 500 Low: 100 (roughly) in March '80
S&P 500 High: 4820 in Jan '22
Actually this is really interesting and I didn't realize this till now running these numbers. The 10 year yield has contracted by 48x while the S&P 500 has gained 48x over the same period... A note on falling rate environments....they're bullish for stocks. We have been in this period of steadily lower rates over time to the tune of 48x and the stock market reflects this favorable environment with the exact same multiple in growth over the same period.
Now, we all know that the FED is on a mission to tame inflation with higher interest rates..Take note of the 10 year low in Mar '20 of .33%. I believe that low will hold for the remainder of our trading careers as we see a period of steadily INCREASING rates to counter this 40 YEAR accommodative run. In the short-med term sure the FED is looking to boost into the 3-3.5% range for their target rate. Be advised that 3% is 6% shy of June CPI (9%) which puts us still in a REAL accommodative rate environment. They're gonna have to match inflation (with target rate) and then some to have it sustainably reverse course. CPI could come down as part of this process and I think it will. Let's say it fall to 6%. Better, right? We'd still need a fed target rate at 7% + to meaningfully throw water on inflationary forces. I guess what I'm saying is...3.5% is a neat target, but we'll have much higher to go beyond that. I see this as a give and take over the coming years as rates make new highs which puts equities in a tough position until this process plays out. I'm kind of looking at 2000-2003 period of multiple contraction post dot com bubble as a reference for this current environment. Sorry, the bottom is not in and it could take years to get there.
Ok all that said I wanted to also clarify some things regarding Quantitative Easing and what it actually means when we say the Fed is "Printing" Money. The Fed engaged in QE first time around in November 2008. I remember pretty well as I was working in Midtown Manhattan for an asset management firm and we were in the thickest part of the financial crisis. CNBC was on perpetually for our desk of sales people...Anyway I see a lot of folks referencing FED printing and their balance sheet but often the context or implication of this concept is apparently misunderstood by many in TV chats and comments. Being a nerd, and having worked for the largest bond manager during the first QE, the firm was with was instrumental in helping guide the fed through that stretch...I'm gonna lay out how QE works for all to observe (if you are not clear already).
Quantitative Easing (QE) is when the FED purchases US Treasuries and or US mortgage backed bonds from the open market. The real purpose of this strategy is to lower or maintain low borrowing rates for the US Gov, US mortgage borrowers (homeowners) and by extension bc the US Treasury is the benchmark, all debt and borrowing rates. QE is typically employed as a supplemental strategy once the actual FED target rate is at or near 0%...can't go lower right? Wrong, kinda....this is where the FED would likely utilize QE if rates at 0 but they still wanted to do more to stimulate growth/be accomodative. When the FED buys US treasuries or mortgage backs, it sends those yields lower. This rate influence impacts the entire bond and rates markets by extension as a lower benchmark bc there's a huge buyer of US bonds! the FED to the recent tune of $9 Trillion. I'll pose the question..."where'd they get the money?" They just kind of acted as if they had it....and bought the bonds...and held em. Without actually printing it, the impact of this is as if there were 9T more dollars in circulation and far more demand for treasuries than is reality.... They lowered interest rates without changing their target rate (which was already at 0%) and did so by theoretically "printing" the money to make the purchases. That's it, that's QE. Worth mentioning that we are now in QT (tightening) and they are selling those same bonds back effectively removing the "as if" 9T from circulation.....it never really was in circulation but QE simulates as if it were...This selling of US Treasuries and MBS is what they refer to as reducing or unwinding their balance sheet. $95 B/ month currently I believe.. Bear in mind that these sales will have the opposite impact on rates as the purchases so while the fed is raising their target rate 50-75bps per meeting, there is an additional impact on the bond market from QT.... If you read this far my hat's off to you. Hopefully someone learned something...thanks
~B
I wanted to post a few thoughts of the somewhat educational variety. Hopefully this will help with perspective on where we've been and why I continue to see equity market weakness for the extended and foreseeable future (1-3 years maybe). So starting with this chart, this is the 10 year US Treasury yield below and the S&P 500 index above going back to approx. 1980. It's log scale to make each asset more meaningfully represented. What we notice about the 10 year yield relative to equities throughout this ENTIRE 40+ year period is that it has been on a steady declining slope as the S&P has seen significant growth and gains. The numbers for each over this stretch are as follows.
10 Yr Yield High: 16% (nearly) in Sep '81
10 Yr Yield Low: .33% in March '20
S&P 500 Low: 100 (roughly) in March '80
S&P 500 High: 4820 in Jan '22
Actually this is really interesting and I didn't realize this till now running these numbers. The 10 year yield has contracted by 48x while the S&P 500 has gained 48x over the same period... A note on falling rate environments....they're bullish for stocks. We have been in this period of steadily lower rates over time to the tune of 48x and the stock market reflects this favorable environment with the exact same multiple in growth over the same period.
Now, we all know that the FED is on a mission to tame inflation with higher interest rates..Take note of the 10 year low in Mar '20 of .33%. I believe that low will hold for the remainder of our trading careers as we see a period of steadily INCREASING rates to counter this 40 YEAR accommodative run. In the short-med term sure the FED is looking to boost into the 3-3.5% range for their target rate. Be advised that 3% is 6% shy of June CPI (9%) which puts us still in a REAL accommodative rate environment. They're gonna have to match inflation (with target rate) and then some to have it sustainably reverse course. CPI could come down as part of this process and I think it will. Let's say it fall to 6%. Better, right? We'd still need a fed target rate at 7% + to meaningfully throw water on inflationary forces. I guess what I'm saying is...3.5% is a neat target, but we'll have much higher to go beyond that. I see this as a give and take over the coming years as rates make new highs which puts equities in a tough position until this process plays out. I'm kind of looking at 2000-2003 period of multiple contraction post dot com bubble as a reference for this current environment. Sorry, the bottom is not in and it could take years to get there.
Ok all that said I wanted to also clarify some things regarding Quantitative Easing and what it actually means when we say the Fed is "Printing" Money. The Fed engaged in QE first time around in November 2008. I remember pretty well as I was working in Midtown Manhattan for an asset management firm and we were in the thickest part of the financial crisis. CNBC was on perpetually for our desk of sales people...Anyway I see a lot of folks referencing FED printing and their balance sheet but often the context or implication of this concept is apparently misunderstood by many in TV chats and comments. Being a nerd, and having worked for the largest bond manager during the first QE, the firm was with was instrumental in helping guide the fed through that stretch...I'm gonna lay out how QE works for all to observe (if you are not clear already).
Quantitative Easing (QE) is when the FED purchases US Treasuries and or US mortgage backed bonds from the open market. The real purpose of this strategy is to lower or maintain low borrowing rates for the US Gov, US mortgage borrowers (homeowners) and by extension bc the US Treasury is the benchmark, all debt and borrowing rates. QE is typically employed as a supplemental strategy once the actual FED target rate is at or near 0%...can't go lower right? Wrong, kinda....this is where the FED would likely utilize QE if rates at 0 but they still wanted to do more to stimulate growth/be accomodative. When the FED buys US treasuries or mortgage backs, it sends those yields lower. This rate influence impacts the entire bond and rates markets by extension as a lower benchmark bc there's a huge buyer of US bonds! the FED to the recent tune of $9 Trillion. I'll pose the question..."where'd they get the money?" They just kind of acted as if they had it....and bought the bonds...and held em. Without actually printing it, the impact of this is as if there were 9T more dollars in circulation and far more demand for treasuries than is reality.... They lowered interest rates without changing their target rate (which was already at 0%) and did so by theoretically "printing" the money to make the purchases. That's it, that's QE. Worth mentioning that we are now in QT (tightening) and they are selling those same bonds back effectively removing the "as if" 9T from circulation.....it never really was in circulation but QE simulates as if it were...This selling of US Treasuries and MBS is what they refer to as reducing or unwinding their balance sheet. $95 B/ month currently I believe.. Bear in mind that these sales will have the opposite impact on rates as the purchases so while the fed is raising their target rate 50-75bps per meeting, there is an additional impact on the bond market from QT.... If you read this far my hat's off to you. Hopefully someone learned something...thanks
~B
Note
I'm gonna make one last appeal to all in TV chats...Please stop villianizing BlackRock. When I see that in here I cringe...because it's clear that that person doesn't have a clue what they do or how wall st actually works... Ok listen I'm not here to praise or defend them either. It's just this. They became HUGE like 9T asset manager. Always remember tho when you're talking S#!^....they manage other peoples money...not theirs. So when they're buying up "all the real estate", it's because their real estate strategy funds had more inflows prob from retail investors.. At the end of the day, they manage mutual funds, ETFS, pensions, etc...for YOU & ME and MOM & POP and also Institutions...if you have a 401K BLK manages it or some funds in it...They own so many assets because their investment policy statatements (IPS) dictate that they must have at least X % invested in X assets depending on the strategy.. stocks, bonds real estate..etc...You want a villian let's talk about Goldman, JPM, CITI, etc... the investment banks...then we're getting somewhere. (full disclosure I worked at BLK for 3 years, have no current allegiance but do understand what they do, just trying educate). And if you didn't know.....now you know
Note
Forgot to say... the only reason that they have become everyone's favorite villian is because they are so large in assets..That's it. If you are blindly hating, you're reading the wrong media. Sorry but if you do I'm going to assume that you're kind of a dumbass / ignorant. There. I just had to, for your sake.Note
Ok one more tie in to both the 40 year decline in rates/equity gains and QE..I mentioned that I'm not optimistic about stocks for as far as we can see. (prob 1-3 years), There are a number of reasons for this, I'm just gonna make a list of things that come to mind:Higher interest rates
Alarmingly high inflation
War in Ukraine
High cost of energy
Ok the above are all obvious and I do believe that these things have been priced into the market already. It's what the above lead to that has me more concerned and extends that out a long way:
Higher cost of and therefore, less borrowing (from individuals to institutions)
Less free capital at corporations (bc both higher rates and energy costs
Diminishing earnings capabilities (from all of the same)
Slowdowns in hiring
The above leads to the below:
Economic contraction.....a recession, ok? Got that Biden? Yellen? Don't lie to yourselves...We're In a recession or we will be in one per the history books. I said it in April when Q1 GDP posted negative...
The question from here is, how much of this economic contraction has been priced in and how deep and long with said recession be? The latter we can't know yet. I think we've addressed the first group taking the obvious earnings multiples that were possible at lower rates off the table. For reference trailing 12 month PE S&P is 22 while the more impactful 10 yr CAPE is 30. Both still suggest overvalued and that is with current healthy earnings.. If earnings decline even more-so. I don't think we made much of a dent yet pricing in recession. That's what Septembers and Octobers are for ;)
Note
Oh and I forgot one very important catalyst from the list. A lack of QE...we've had FED imposing their will on market forces twice now in the past 15 years. That's a lot of voodoo economic engineering...anyway, we can agree that FOR NOW we will not be entering a new round of QE but remember that QE was present for almost the entire stretch from late 2008 to present ie during this long bull run. (excepting spring '20 and this year.) Just remember that QE isn't normal conditions and many of us have accustomed to strong market rallies in this environment...Without a QE fix, what can be expected of a bull market? Not nothing, but prob not the crack fueled animal that we are now used to. I'm gonna end my day of word purging with this. IF WE DO see another round of QE in the near future, as response to recession/contraction, (and I'm kind of expecting that we will), I think the conversation may shift to "can the market perform without it?", and more importantly, will the ensuing inflation dethrone the US dollar as the global reserve currency? Enough from me. ThanksNote
Hey all. There has been a correction nagging me for awhile regarding my run through of QE (and QT actually). To clarify...while the fed does not actually print physcial paper dollars...it does create digital credits representing the "printed" dollars... they then use those made up amounts to buy treasuries and MBS...saying it that way makes it sound like cheating...Also regarding QT, they are actually not selling bonds back into the open market.. rather simply letting their holdings mature and roll off their books. That is a better and less impactful way to reduce their balance sheet. The real thing to note is that they are NOT purchasing them any longer...just letting them mature and roll..
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