Yesterday, the largest single day gain in the S&P500 (SPX) in 2014 was completely mental in my opinion, having little to do with the fact that the direction was up. To be fair, I thought the previous day’s 1.5% decline was a bit overdone, for a single day’s action. The main point I want to make though is the pick up in realized volatility for the one risk asset the world over which has NOT been volatile is not exactly a bullish sign at a time when there appears to be an insatiable demand for govt debt, with U.S. Treasury yields making fresh 52 week lows this morning. The table below showing almost every major 10 yr yield for western govt debt (including Japan) at 52 lows, well below the avg (look at the Range column near the right), Per Bloomberg:
So it doesn’t strike me as that odd that equities remain attractive relative to govt bonds, but what does strike me as odd is the voracity with which investors bought stocks in the U.S. yesterday given the catalyst. The Federal Reserve is nearly done with QE, but market participants have been more worried that the Fed will jump the gun and raise rates too soon given the fragility of our economy at a time when Europe and many emerging markets appear to be flirting with a recession.
As Joe Weisenthal of Business Insider pointed out yesterday:
“It Took Just 2 Sentences From The Fed To Make The Stock Market Go Wild”
Here they are:
Some participants expressed concern that the persistent shortfall of economic growth and inflation in the euro area could lead to a further appreciation of the dollar and have adverse effects on the US external sector.
At the same time, a couple of participants pointed out that the appreciation of the dollar might also tend to slow the gradual increase in inflation toward the FOMC’s 2% goal.
So when the Fed a couple weeks ago stated that they would not raise rates for a “considerable time” they meant it. They are very worried about tipping the scales here in the U.S. given all of the external fears to growth, unexpected strength in the dollar, and lack of inflation at this stage of the recovery.
I guess from where we sit, something has to give, and soon. Either U.S. data starts to go the way of Europe and China, and low yields are likely to be a function of the weakness in growth rather than Central Bank policy, and thus equities finally take a breather. Or the Fed’s patience on the rate front and their wordsmith abilities keep us in the game, and if and when global growth resumes, we are all set to continue to make higher highs in the orderly fashion we have over what has been an unprecedented period of low volatility.
The bond market is signaling a major growth scare. Equities seem comfortable that lower rates for longer from the Fed could remain an important growth stimulant. However, the lack of follow through overnight from international equities (Japan closed lower, and Europe is in the red) diverges with that view. At this juncture, buyers of U.S. stocks are playing a confidence game, while other financial markets like bonds and currencies have lost much of their confidence in the ability of low rates to generate growth traction. If the recent bout of volatility is the start of a change in conversation, then U.S. stock investors’ views will soon converge lower to that of other markets.
The time for honoring equities at the altar of low yields may soon be at an end.