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Bonds Versus Stocks - Just Ask Japan

Tyler Durden's picture




 

Submitted by Lance Roberts of Street Talk Live blog,

The great "bond bull market" is dead.  

Interest rates are rising on expectations of stronger economic growth ahead

The "great rotation" from bonds to stocks is afoot.

These are all statements I have heard being made over the last month as 10-year interest rates went on a surge from deeply oversold levels to grossly overbought levels during that time span.  The question, of course, is whether the stock market continue in its current bull market trajectory in the face of higher interest rates?  Today's chart of the day is an overlay of the 10-year treasury rate and the S&P 500.

Interest-Rate-SP500-061713

I have noted several things of importance in the chart above:

  • The vertical dashed lines denote when rising interest rates either led to a correction in asset prices or an economic recession.

  • I have noted major events for a chronological perspective.

  • The secular bull market of the 80-90's was spurred by falling interest rates and inflationary pressures which boosted corporate profitability.   With the markets valued at roughly 7x earnings with a near 6% dividend yield the markets were primed for credit expansion fueled stock market boom.

  • I have noted (red circle) the recent "surge" in interest rates for some perspective.  While the recent rise has certainly gotten the markets attention as of late; from a historical perspective we are still well within the confines of the current long term downtrend.  

  • I have also noted the similarity between the secular bull market in the 60-70's versus 2000 to present.   The breakout to "all time" highs is not necessarily an indication of the beginning of new "secular bull market".   With valuations currently 19x earnings on an trailing reported basis, earnings growth peaking for the current economic cycle and sub-par economic growth rates; the fundamental backdrop for a continued bull market from current levels is not available.

The "bull case" for the continued run in equities has been built around the continuation of monetary interventions from the Federal Reserve and a near zero-interest rate policy.   However, if interest rates begin do begin to rise in earnest the fundamental backdrop changes dramatically:

  • People buy "payments" rather than houses.  Therefore, the much vaulted support from the sub-3% contribution from housing to the economy will dissipate rapidly as demand slows and prices fall to find buyers.

  • Mortgage refinancing activity will slow to a stop.  (Who refinances to higher mortgage payments)

  • Higher interest rates make speculative home buying much less attractive.

  • Personal consumption expenditures (which make up nearly 70% of GDP) will be negatively impacted as the rising costs of variable rate credit lowers discretionary incomes.

  • Corporate earnings will decline as higher borrowing costs impact profitability.

  • Corporate capital expenditures will slow as higher borrowing costs reduce the attractiveness of returns on new projects.

  • Markets will be negatively impacted as higher leverage costs reduce profitability.

  • Corporate bond issuance will slow sharply as borrowing costs surge.

  • "Junk Bonds" will come under duress as higher interest rates sap funding for troubled companies leading to defaults and bankruptcies.

  • Highly indebted municipalities are likely to be "shut out" of the municipal bond markets to obtain funding leading to defaults (i.e. Detroit)

  • Higher interest rates will blow a massive hole in the CBO's government budget and deficit forecasts.

The list goes on but you get the idea.   The impact of substantially higher interest rates are not good for the economy or the financial markets going forward.  In the short term consumers, and the financial markets, can withstand small incremental shifts higher in interest rates.  There is clear evidence historically to suggest the same.  However, sustained higher, and rising, interest rates are another matter entirely.

However, before you get to excited, look back at that red circle in the lower right corner of the chart above.  It is important to keep in perspective the recent "surge" in interest rates that has gotten the market's attention as of late.  In reality, this is nothing more than a bounce in a very sustained downtrend.  Is the bond "bull market" extremely long in the tooth?  You bet.   Does that mean that interest rates are set to surge higher in the near future?  No.

While there is not a tremendous amount of downside left for interest rates to go currently - it also doesn't mean that they are going to substantially rise anytime soon.  Weak economic growth, an aging demographic, rising governmental debt burdens and continued deflationary pressures can keep interest rates suppressed for a very long time.  Just ask Japan.

 

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Mon, 06/17/2013 - 16:04 | 3665791 kliguy38
kliguy38's picture

Still time for the suckers to jump on

Mon, 06/17/2013 - 16:12 | 3665810 Gringo Viejo
Gringo Viejo's picture

SCOTUS RULES NO ID NECESSARY TO VOTE!

NOW OFFICIAL!

YOU HAVE NO MEANS FOR REDRESS OF GRIEVENCES!

Mon, 06/17/2013 - 16:16 | 3665817 lolmao500
lolmao500's picture

Well duh. SCOTUS are a bunch of sellouts... They don't give a fuck about the rule of law or the constitution. Hell they ruled Obamacare legal and protesting peacefully on scotus grounds illegal.

All 3 branches are treasonous.

Mon, 06/17/2013 - 16:54 | 3665905 RockyRacoon
RockyRacoon's picture

Rule of law.

How quaint.

Now, can we see that chart above in inflation-adjusted dollars?

Mon, 06/17/2013 - 16:20 | 3665828 Dr. Engali
Dr. Engali's picture

"YOU HAVE NO MEANS FOR REDRESS OF GRIEVENCES"!

 

The founding fathers would disagree with that statement. Then again the founding fathers weren't sedated with flouride, dumbed down with television, and fattened to the point where it's considered exercise to reach for the remote.

Mon, 06/17/2013 - 21:20 | 3666588 thestarl
thestarl's picture

As usual you nailed it Dr E LOL

Mon, 06/17/2013 - 16:21 | 3665830 q99x2
q99x2's picture

Good, I'm going to Arizona to vote McCain out of office.

Mon, 06/17/2013 - 16:48 | 3665893 Quinvarius
Quinvarius's picture

Sign me up for a 50 states voting tour.

Mon, 06/17/2013 - 16:07 | 3665796 JJ McApe
JJ McApe's picture

uggh damn abe bro, it is futile

Mon, 06/17/2013 - 16:07 | 3665799 bank guy in Brussels
bank guy in Brussels's picture

And the biggest reason of all for rates not to rise :

« You cannot predict higher interest rates if you also predict QE to infinity. QE is the non-economic purchase of government and other debt securities. Therefore as long as QE expands to meet the size of bond offering, the bond market will stay bullish and interest rates will not rise significantly. »

- Jim Sinclair, JS Mineset

Mon, 06/17/2013 - 16:16 | 3665821 lolmao500
lolmao500's picture

You cannot predict higher interest rates if you also predict QE to infinity.

Sure you can... SEE : JAPAN.

Mon, 06/17/2013 - 16:15 | 3665814 disabledvet
disabledvet's picture

my bull case rests on entirely NEW markets being created and "USA Incorporated being able to get first mover advantage" and thus monetize said market before "all the followers come along." i have no idea what the averages will do, whether they are over bought or over sold...i will say the Fed has not been this friendly SINCE the 1980's...so even though the recovery stinks...and it does...unless and until you believe the Fed will "bankrupt the country" (instead of merely the world like they did in 2008) then i'm not buying the bear thesis. in an IDEAL world we'd actually have some growth in the economy...but here in the USA and globally...to hang our hats on. WE DO NOT. That SHOULD mean "equities cool off"...BUT THEY HAVE NOT AND I HAVE BEEN WRONG. .... SORRY. MY CRYSTAL BALL IS OFF A LITTLE OF LATE. http://www.youtube.com/watch?v=EEEzbFxEbB8 something's you just don't see coming. like "rock and roll."

Mon, 06/17/2013 - 16:21 | 3665827 joeknows
joeknows's picture

I believe that is an expaning wedge reversal pattern from the top....

Mon, 06/17/2013 - 16:27 | 3665848 Unknown Poster
Unknown Poster's picture

Without money hot off the press who would lend into this bad debt trainwreck? Especially at these ridiculous rates.

Mon, 06/17/2013 - 16:27 | 3665849 Midasking
Midasking's picture

As a contarian I love the value I see in the long term 30yr for a long term hold. Only wish they had 50 treasuries... http://tinyurl.com/mem7o7x

Mon, 06/17/2013 - 16:33 | 3665860 Son of Loki
Son of Loki's picture

4.25% mortgage rates have frozen the housing market where I live. Everyone is [justifiably] scared stiff that house prices will sink lower fast with the rising rates.

Gee, wonder if they are just waking up to concepts such as "reversion to the mean"?

Mon, 06/17/2013 - 17:08 | 3665938 max2205
max2205's picture

Nope. They will panic to get a fixed low rate 1st

Mon, 06/17/2013 - 16:54 | 3665906 SheepDog-One
SheepDog-One's picture

OH I see....they're still looking for 'economic forces' in the 100% life supported markets. How quaint.

Mon, 06/17/2013 - 17:25 | 3665965 Madcow
Madcow's picture

Japan shows the denouement can be postponed indefinitely. So long as indefinitely remains the US - and others - can follow that same path.

As soon as indefinitly reaches a finite conclusion (and is no longer indefinite), the markets will immediatly discount future inevitablity into current price structures

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