Commentary: Are rising interest rates a reason to be bullish?
Some Bulls believe rising interest rates are a bullish indicator of strengthening underlying economy. I would contend that is no longer true for two reasons:
1) I think this market is driven by Central Bank liquidity (QE), not the underlying economy. Loans aren’t being made. There is very little worldwide growth. And yet, both stocks and bonds have climbed dramatically over the last 4 years. Why? Because the system has been flooded with money that has nowhere better to go (Corporations are doing buybacks rather than investing in Cap-Ex spending – a very bad sign, consumer lending remains very tepid, etc). In a “normal” paradigm, as he describes, a strengthening economy means stocks go up (more growth, more inflation) and bonds go down (less desire for safety of a fixed return). This paradigm has basically been broken for the last four years, as both stocks AND bonds have risen on a tide of liquidity.
The warning shot that was fired yesterday (and has been hinted at for a few weeks now) is a scenario where liquidity drains from the system and everything goes down in tandem. Stocks, bonds, gold. Never should all three be going down together. They are opposite ideas. If two are bad, the other should be good. For all to be falling hard says that liquidity is coming out, period. It’s not strategy, it’s not the economy, it’s a need by market participants to raise cash.
2) My view is that the economic paradigm upon which capital markets are formed has been deformed by Central Bank intervention:
“History tells us that the Market actually rises more than 80% of the time when interest rates are rising. Why? Because, if the Fed is raising interest rates, it usually is because the economy is improving.”
This quote was from a different commentary, and gives the correct textbook answer for what rising interest rates should indicate about an economy, and what he describes is how capital markets have generally functioned through history. It is how they are designed to work in theory. BUT that scenario presumes an interest rate that is sensitive to market forces. Ours is not. The Fed sets it, basically at their whim. The idea is that greater demand for debt means borrowers are willing to pay more in interest, which makes sense in a textbook (or real life, where the market and not a Central Bank sets the rate). However, our Fed sets the Effective Fed Funds Rate where it sees fit, regardless of whether demand is robust or slack (see: Greenspan 1998 rate cut). Market forces don’t drive down the rate due to lack of demand, nor does robust demand drive rates up. The Fed responds to its perception of those forces by adjusting accordingly, but the direct correlation that exists in textbooks is not the reality. What this has done, I believe, over time, is warp the credit market. By offering ever-cheaper credit in the hopes of spurring growth and maintaining asset prices, the Fed has allowed a massive misallocation of capital by never allowing “bad” assets to get fully flushed out of the system.
Incidentally, note what’s happened since 1980.
Recessions have hit with steadily lower and lower interest rates. And now the Fed is zero-bound. The Fed doesn’t have much room to raise rates before hitting what would be a trendline of resistance (2.5 or so). There is no lower they can go. If the best we can get is a piddling 2% growth with interest rates at ZERO for four years… why would higher rates help?
Some make the case that households have improved their balance sheet (see the chart below), but that depends on how the graph was calculated (and I don’t know). Mean or median? If it was simply total national income / total national consumer debt (the mean, typically used for “average”), remember that the top 1% of the population brings in 20% of the national income. So their incredibly low debt service ratio would significantly skew the national average, making it look much healthier than it is for the median household.
But that’s all fundamental stuff, and probably has very little to do with the market in the short term.
As for the charts, yesterday’s ugliness in stocks didn’t break support on enough charts to say there’s a clear breakdown in stocks per say. Another 1% down today would do the trick. But emerging markets are a mess, generally. EEM is sitting on at the “neckline” on a 4 year head-and-shoulders. Copper is also very ugly looking, and continues to flash warning signs. Junk/corporate bonds have broken down decisively. That’s another warning. But yesterday’s action in itself did not constitute a technical breakdown in the major stock indexes.
The chart that has most clearly triggered action is TLT, which broke down from a two-year head and shoulders. Rates look likely to push higher in the mid-term, which should be bullish for stocks. But if the last month is any indication, it is NOT. When bonds and stocks are going down in tandem (as they are doing again today, with violence), I consider it evidence that liquidity, not the economy, that is driving the market.
That how I see it, anyway.