The guest commentary below was written by Mark Bunting of Uncommon Sense Investor on 3/17/21. This piece does not necessarily reflect the opinions of Hedgeye.
The bond market usually gets it right.
And it’s saying Jerome Powell and his crew at the U.S. Federal Reserve may have already made another policy mistake.
The first was to not recognize that inflation in the spring of 2020 was starting to take flight.
It was transitory they said. Wrong-o.
Now, the Fed is projecting six more rate hikes by the end of this year.
This as economic growth and corporate profits are quickly returning to earth after last year’s temporary fiscal stimulus drove eye-popping first and second quarter GDP and earnings numbers.
Good luck to Industrials, Consumer Discretionary, and Financials sector companies, for example, in matching their triple digit second quarter 2021 earnings per share (EPS) growth in the second quarter of this year.
Estimates have EPS still growing double digits, with the exception of energy, but the rate of change slowdown will be massive.
Check out Hedgeye’s helpful S&P 500 Sales and EPS comparison chart.
There are two charts (see below) that really illustrate the Fed’s problem and show that attempting to continue to raise rates into a dramatic economic and profit slowdown will be virtually impossible.
The way U.S. Treasury yields moved on Wednesday after the Fed finally raised its key lending rate for the first time since 2018 was more instructive than what the major stock indices did.
Yes, stocks moved sharply higher into the market close but one could argue that was mostly hedge funds covering their short positions because there’s only been modest follow through today (Thursday).
Bond yields post-Fed initially moved higher but then declined.
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One of the most important charts right now shows where traders, based on overnight index swaps comparing one year expectations of where 10-year and two-year Treasury yields will be, believe that the yield curve is going to invert (two-year yield above the 10-year yield), which usually indicates a recession is coming. |
Short-term rates reflect what the Fed is doing – raising rates – and longer term yields reflect economic growth prospects.
If the Fed continues with its plan to increase rates, stock market investors may not be able take the pain and the Fed, as it did in 2018, will be forced to halt its rate hiking cycle.
What does that mean for investors?
A safe place to hide would be in U.S. dollars (UUP), which should be in favour under that scenario.
In longer term government bonds (TLT), which should rise with yields eventually moving lower.
And in gold (GLD), which acts like a currency and likes it when rates are not going up.
Gold stocks could also benefit but, as we’ve seen when stock sell-offs become severe such as in March of 2020, investors will sell everything, including gold miners.
Here’s a look at an expected inverted yield curve one year out.
Now, please keep reading for Jesse Felder's view of what he thinks may be the most important financial chart in the world at this moment (Click here to read Felder's recent piece, "Are The Bond Vigilantes Back?").
Hedgeye CEO Keith McCullough had the privilege of being interviewed by Mark Bunting for Uncommon Sense Investor in August 2021. You can watch the full interview and read the transcript here.
EDITOR'S NOTE
Mark is a trusted journalist with more than 20 years experience covering capital markets and business on national television as an anchor and reporter with Business News Network (now BNN Bloomberg), including three years in England as BNN’s London Bureau Chief, and with Bloomberg TV Canada. Mark oversees the content produced by Uncommon Sense Investor, where the goal is to provide investors with thoughtful and clear insight, analysis, conversation and education. This piece does not necessarily reflect the opinions of Hedgeye.
