The end of the longest bull market?

Posted by Eric Coffin

on Friday, 12 October 2018 16:54

It’s increasingly looking like we’re now at or near the end of one of the longest running and most important bull markets in history.  No, I’m not talking about Wall St.   I’m talking bonds.  You may be shrugging, but don’t.  Though most retail investors don’t pay much daily attention to the bond market and almost no retail investors trade in it, its arguably the most important market in the world.    The scale of money flows in the bond market dwarfs Wall St and the yields that get set by it have repercussions throughout the economy.

The phrase “the longest bull market in history” sounds like hyperbole but really isn’t.  This bull stretches back to the early 1980’s.  US Fed Chairman Paul Volcker had just finished wrestling inflation to the ground, taking the US economy with it.   He did the right thing, dealing with an inflation spiral through the late 1970’s that was playing havoc though all the world’s markets.  It wasn’t a painless solution but was necessary.  Volcker took the Fed Funds Rate to 20%, not once, but twice, in 1980 and 1981.  That was the highest in history.  When yields began to fall afterwards, in 1982, that marked a bottom for both bond and equity prices.  Both markets then began an historic rise.

Both stocks and bonds entered long term bull markets in 1982.   For Wall St, the run ended in 2000 and again in 2008.  That wasn’t the case for the bond market.  To be sure, it had its ups and downs, but the bull market that started in 1982 has never really faltered and bonds have yet to suffer a true bear market for 37 years.    I think they may be about to though.

I’m not the first person to make this call.  Some of the most successful investors on Wall St have been worried about the bond market for some time now.  Many of them have already called the end to it.   Bond market, and equity, bulls have called them out as being premature.  Perhaps, but its too early for the bulls to claim victory.  If the bond market bears turn out to be right, the market top will be pencilled in at mid-2016, right about when the bond bears really got vocal in calling atop.

Look at the chart above.  Keep in mind this is a long-term, big picture chart and that the individual candles are monthly.  This is a chart of the 10-year Treasury Yield Index.   Remember that bond prices and bond yields move in opposite directions.  Rising bond yields means falling bond prices.   When you look at the chart, you can see that a double bottom may have formed just below the 1.5% with the second bottom in mid-2016.  More important, and timelier, is the fact that the yield has now risen to meet the 200-month moving average.  This is a very long-term average that has helped define a decades long downtrend in rates.  This is a line that hasn’t been crossed before and cutting through the 200-month average would be viewed as a change in a fundamental long-term trend.

How much does this matter?  Potentially, a great deal.  Equities markets can advance while rates are rising.  They often do, in fact.  But we shouldn’t underestimate how large a tailwind falling interest rates has been for the last three decades.  By historic standards, rates are still very low, but the market has become dependent on low rates.  They have created a much lower hurdle for earnings and allowed large companies to finance unprecedented levels of share buybacks and M&A activity.  The markets can survive higher rates, but they may not be able to survive them at current levels.

I still don’t see the short-term makings of a crash but, if yields continue to rise at their recent rate, I think the odds of at least a correction are now very high.  North American equity valuations are very stretched and some of the highest valued sectors have stratospheric price earnings ratios.  It will be difficult, if not impossible, for those P/E ratios to survive under rates even 20-30 basis points higher.

I don’t know where the breaking point for Wall St’s current uptrend will be, but I don’t think its too far above current levels of medium to long term rates.  October’s reputation as a month of big market moves is well earned.  I think it’s a good idea to be more defensive.  Don’t expect the worst but try to be prepared for it.  I don’t think it’s the end of the world but do think we may be in for some turbulence and perhaps a couple of air pockets dead ahead. 

If the correction I expect comes to pass, gold and gold equities are likely to be one of the few beneficiaries.  It may be significant that the market environment of the past week or two, which saw both rising yields and a rising US Dollar index, did not lead to lower gold prices.  I don’t love the idea that gold is being bought as part of a “fear” trade.  That is a fickle underpinning for a market, but that doesn’t mean it won’t work.   Should we see a 10-20% pull back in major stock indices, its likely to be accompanied by gold sector strength.  This year hasn’t been great for the gold market, but I think Q4 could turn out to be a turnaround for the sector.

Good luck and good trading.

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