Stocks are selling-off at the same time that bonds are selling-off. Experts are perplexed. But, this dual selloff can occur in only one environment:
Where the Fed will discontinue buying treasuries, pushing bond prices down, and yields up (i.e. quantitative tightening; herein, “QT”), sans business pricing power and sustainable consumer income growth.
There is no other explanation based on all the present facts and data about the economy. Even if there is inflation (more about this to come), it would not demand such an equities selloff, even with QT, where earnings growth is projected to be solid and wages are climbing. Moreover, though, if there is inflation, energy and the dollar would be rising with rates and inflation pressures, but they are not. There would have to be a ton of inflation for stocks to selloff with bonds- but how could that possibly be- when energy is weakening?
It’s premature and simplistic to assume that investors, collectively, are selling stocks and bonds just to re-balance their portfolios due to higher inflation. To accept that, we first need proof of persistently higher wage and price inflation as the causes of higher 10 and 30 yr. Treasury note yields. The dollar has weakened while rates have risen, the Fed has not changed its plan of slow and steady normalization, energy is weakening, and Neel Kashkari and Janet Yellen are expressly dubious about persistent wage and pricing pressures (Kashkari said, “[t]here still may be some slack in the labor market”; and that wage growth in the recent jobs report “could be a blip”). The wage data in the January employment report had lots of holes in it: weekly hours worked were down; the labor participation rate is down; there is historically low wage growth, in general; many states mandated minimum wage increases; we are late in the economic and wage cycles; much of the wage growth was in real estate, which is cyclical; there is little to no pricing power for businesses, which is necessary for sustainable wage growth; plus several other factors that present doubt as to persistent wage pressures – so there is no real cause for sudden inflation fears.
When investors expect inflation, they don’t sell bonds for the purpose of making longer term interest rates rise, or because longer term interest rates will rise, magically, from inflation. That is faulty logic. What happens is that investors seek ways to benefit from inflation- such as through energy, commodities, or even equities- and this movement of capital from bonds to other asset classes causes interest rates to rise. The goal of bond sellers is not to make interest rates rise, the goal is to benefit- or at least be protected- from inflation. Following an inflationary report, such as on wages, bond sellers with inflation concerns would not sell their bonds, and do nothing (cash loses value in inflationary environments). Yet, energy, gold, and stocks, asset classes to own in inflationary environments, have been level to down, and investors are in cash, all of which are even more evidence that it is QT, not inflation, that has been spooking investors. In fact, it’s QT without inflation- without wage growth for consumers and homebuyers to manage higher borrowing costs, without pricing power for businesses so they can pass-through their higher costs of capital- that is scaring equities investors.
There is nothing- nothing at all- that proves, or is even good evidence of inflation- certainly not the, overall, tepid and modest recent employment and PCE reports.
Finally, equities often rise, not fall, with inflation, because it gives businesses pricing power.
In a deflationary or recessionary environment, stocks can crash, but bond prices should rise (as investors search for yield). If investors were forecasting deflation or recession, they would buy bonds and flatten the yield curve, not steepen it. But- in the case of QT, the QT, itself, may cause the deflation, prompting investors to sell stocks- without buying bonds, since QT will force bond prices lower (helping with yield, but hurting principal). Decreases in energy prices, a weakening dollar, and consolidating equities, may be indicating investor sentiment toward a deflationary environment as the Fed “forces” yields higher on all ends of the curve. But deflationary sentiment, itself, did not cause the dual (stock “and” bond) selloff, and interest rates to rise (that wouldn’t make any sense); QT caused the bond selloff and interest rates to rise, followed by the stock selloff because of QT’s likely deflationary effect.
There is really nothing surprising about this dual selloff. Deficits matter, and the Fed wants to normalize its balance sheet. It is common knowledge that the Fed kills bull markets.
Janet Yellen thinks there could be a real estate bubble, which, in my opinion, was Ms. Yellen’s primary impetus for beginning to raise the Fed funds rate- not because of wage or PCE pressures. We do, in fact, have asset inflation (bubbles, perhaps).
Alan Greenspan acknowledged stock and bond bubbles- but made no claims about wage or price inflation. He believes in long term inflation due to the debt and deficits- which will hurt the dollar- which is, arguably, happening now. But, he also notes we are at risk for stagflation– asset price growth without economic growth (so, that does not indicate a risk of unruly wage and income growth … just the opposite).
Everything lines-up for a QT causation theory. Growth “and” bonds should, and would, be implicated in a QT environment. These recent selloffs are less of a worry, primarily, about growth and earnings, than a concern about bond prices for bond investors, and, collaterally, higher debt costs that will result for businesses, consumers, and homebuyers (which, of course, would affect growth and earnings). Anticipation of QT taking bond prices down, while deflating assets and equities through higher interest rates combined with tepid wage growth, with no ability of businesses to pass-through the higher borrowing costs, is the causal event of the simultaneous stock and bond market selloffs.
Of course, certain financial products and computer programmed algorithms have enhanced the selling.
Even if inflation is showing up in CPI and PPI reports, it is likely mostly due to the weakening dollar causing higher prices for businesses and consumers. This kind of inflation (rather than demand or wage driven inflation) makes it all the more problematic that wages are not really rising while interest rates are. This scenario buries the consumer with higher borrowing costs and higher product prices, but little to no wage growth (in fact a weaker dollar lowers real wages). This also burdens businesses with costs that they can’t easily pass on to consumers. So everyone’s costs go up. So far, I see the recent price index increases as unremarkable and unsustainable.
I do not believe that investors think that we have a risk of sustainable long-term inflation- I believe that investors think the risk is of deflation– especially now, as interest rates rise without proof of sustainable income growth. The dollar may be in agreement with this position. Energy, too. Maybe stocks, also- we’ll see.
Watch the dollar. Watch upcoming wage data. Listen to what business leaders say about their pricing power. Deflation is the risk- especially if yields rise- and incomes don’t. Remember- true and organic business earnings can’t increase on the back of a consumer who has stagnant wages and higher debt costs. If QT pushes rates up further, without wage inflation, it would be a major problem, particularly in the context of an overheated housing market.
If equities markets turn up from here while yields rise, with energy and the dollar also gaining, and, especially, if future employment data confirms wage pressures, I could rethink QT being the primary protagonist. Let’s see what equities do from here and what forthcoming wage data exhibit. Time will tell.
- In general, interest rates are rising on all ends of the curve for reasons other than rising wages and from businesses passing costs through to consumers, including due to Fed rate hikes to control further asset (housing) inflation, growing bond supplies resulting from QT, new bond issues from the the U.S. Treasury, and bond selling by other nations and U.S. corporations.
- Financial “professionals” think that investors are reacting to the wage report … and they are right. Investors are reacting to the wage report … to the weakness of it! Investors see a weak PCE number and weak wage growth while the Fed is raising rates on all ends of the curve with hikes and quantitative tightening. There is no safety in stocks, bonds, real estate (home-builders), energy, bank stocks … This is why everything is lower- because of weak wages, not because of higher wages. Investors fear de-flation, not in-flation. For example, how would you expect housing to do with stagnant or only slightly higher incomes, along with rapidly rising interest rates?
- To be clear, investors cannot even hide in bonds because QT is taking the Fed bid out of the market, and investors would lose principal. This aspect is helping yields go even higher, still.
- The U.S. government and Japan have also added to our bond supply.
- Stock analysts are reminding markets that even though stocks and bonds are performing poorly, the economic fundamentals and earnings stories are still intact. I find this curious, at the least. Interest rates (i.e. cost of capital, i.e. operations costs) have risen rapidly and suddenly, yet not even one earnings revision has come out. What about energy company earnings? What about home builder earnings? Does cost of capital suddenly not matter in business? What about businesses’ customers to whom they sell their products- don’t higher debt costs affect their customers’ spending? Stock analysts go on television to explain that it’s normal for higher interest rates to cause stock price multiples and P/E ratios to compress. But what about revenues and earnings? Don’t higher borrowing costs cause those to compress?
- QT and interest rate hikes will lead to a reduction in money growth and money supplies and velocity, which could be deflationary and recessionary. While a more detailed discussion of money supply is beyond the scope of this article, the issue is worthy of mention as part of a discussion about how QT can negatively affect investor sentiment about both bonds and stocks, simultaneously.
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About the Author
Neil Siskind is: President of The Siskind Law Firm, focused on product investments, trademark licensing, product distribution, and real estate; Founder & Chairman of The Fatherhood Assignment™, a think tank and advocate for children with absentee fathers; Founder of the global charity marketing initiative, Caring is Free®; Founder of National Fatherhood Day™; Owner & Conservator of The Neil S. Siskind Nature Preserve, over 8 acres of conserved waterfront land along New York’s majestic Hudson River; and author of The Complete Guide To The Ways To Manufacture & Sell Your Products. If you are in need of office space in South Florida, contact Neil Siskind about space availability at The Siskind Executive Office Complex in Boca Raton, FL.
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