Historically, bond and stock correlations have never been stable over a period of decades; they go back and forth depending upon whether markets are worried about inflation or deflation. In the US, there are concerns over growing inflation, but surprisingly any uptick in price levels are missing.
So, yields have been down for most of the year and stocks have been up. Stated another way, stock and bond prices have been going up. If inflation had been the real threat, stock and bond prices would have been going down. Investors can not hide anywhere in the financial assets sectors when inflation goes up, though it’s possible to hide in the commodities markets.
The relationship between equities and fixed-income securities has changed over the last 18 months. Investors need to understand when stocks and bonds go up together, like they have been doing this year, they eventually go down together as well, he noted.
US bond prices have been declining over the past few days while yields have been going up. Asked if they suggest anything, Jim said they possibly suggest nothing as yet. There has been a typical pattern all year where yields go up in the first week of the month and then go down for the rest of the month.
So far, the rise in yields is just following that pattern and it’s difficult to explain that pattern. The rise in 10-year yields to 2.54 percent is nothing alarming, and the technicians are unlikely to tell they have breached any key resistance level. It’s possibly just ebb and flow in a market that still has larger trend towards lower yields, he observed.
Asked to comment on the recent observation by San Francisco Fed that policymakers follow data much more closely than investors think, Jim expressed doubt in the Fed’s claim. The truth of the matter is that the Fed has tried to end quantitative easing three times since 2009 and this is their fourth attempt.
Markets were skeptical if the Fed was done with money printing during the first three times, and the Fed actually came back and started quantitative easing again. They are suffering from their own history. When policymakers stop QE, stock markets fall and then the Fed comes back and restarts the process. The market is right to be skeptical about the Fed because of the central bank’s track record. The Fed claims it is done with QE, but they are never quite done, he argued.
Asked to comment on the FOMC meeting scheduled next week, Jim said everybody expects the Fed to announce a further cutback of $15 billion in asset purchases and there’s no surprise in that.
However, investors should watch-out if there’s a change in language, and the specific part of it are the words “considerable time.” The Fed has been saying “it will be a considerable time before the central bank raises rates.” It’s likely the Fed will drop that phrase, but in the next meeting in October. Because in October, they will be finished with tapering and sequentially it makes more sense to drop that phrase then.
However, chances of the Fed dropping that phrase in next week’s meeting also remain and it can happen either this month or in October. After they drop that phrase, the stage will be set for initiating a discussion on raising rates in 2015, he noted.
Asked to comment of US’ economic fundamentals, Jim said it has been more of the same for the last four years where growth has been sub-par at 2 percent. Investors should not expect huge earnings growth going forward. The S&P 500 is up 8 percent this year while earnings growth has averaged around 4-6 six percent. Until something fundamentally changes, which is unlikely to happen, investors can expect lackluster economic growth and low earnings growth in single digits, he concluded.
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