During the worst of the chaos that unfolded at the Capitol yesterday, I received several calls and texts from friends and reporters alike. They all wondered why the market was not plunging on the chaos that was unfolding on their TV screens. The answer that I gave the New York Times was representative of my take: “It’s impossible to put a positive spin of what’s going on in Washington…It’s disturbing but it ultimately doesn’t really change the long-term picture, at least as it stands now.” If that wasn’t the market’s consensus yesterday afternoon, it is certainly the case today.
Prior to yesterday’s chaos, we wrote how the market seemed to decide that any news that could reasonably considered as bullish would indeed be considered that way. The counterpart to that rosy outlook is that any obviously bearish news would be given the most benign spin possible. That was the rationale for why we saw only modest profit taking while the events were occurring and why we resumed the rally with force this morning.
By now, some of the $600 stimulus checks have made it into people’s bank accounts. Since it is so easy to wire money from bank to brokerage accounts, it is quite reasonable to believe that much of the rally that we see is being fueled by that wave of money. And because markets and investors alike are addicted to the prospects for further stimulus, we are already looking forward to the prospect of an additional round of $2000 checks in the near future. How could markets not react favorably to that prospect?
Well, if you’re a government bond trader, you don’t find this prospect as appealing. The money for the stimulus needs to come from somewhere, and that source of funds is the US Treasury market. Yields on 10-year T-bonds rose from 0.914% on Monday to 1.08% as I write this. That is over 16.5 basis points, or an 18% jump – a fairly staggering move in a short period of time. The fall in the bond price itself was 1.56 points– less startling, but still dramatic. Those bonds are quite sensitive to inflationary expectations, and it is clear that those expectations have risen. Remember that low bond rates have been used as a justification for abnormally high equity valuations. Momentum traders don’t care about such things, but fundamental investors do.
It’s not all bad news from the bond market though. Bloomberg reported that US junk bond yields fell to a record low 4.16% today. Putting aside the possible lunacy of investors demanding only a 3% premium to accept highly risky credit in lieu of a bond with no credit risk, those low rates mean that almost any reasonable company can raise money from bond markets with relative ease. That is certainly a positive factor for equity pricing.
As we circle back to the theme of “all news gets a positive spin”, there is of course one major cloud in the “Blue Wave” outlook. The same bill that could grant additional stimulus could also bring higher taxes. While many have a sanguine outlook about a filibuster-proof divided Senate, the most recent round of tax cuts was passed using the budget reconciliation process. That requires only a simple majority. President-elect Biden’s platform included income and capital gains tax increases for high income earners and a rollback for some of the recent corporate tax cuts. Sorry, but I have no way to spin higher taxes in a bullish manner.
For now, investors might as well enjoy the fun. But if the recent enthusiasm was a short-term sugar rush, fueled by $600 checks, there may be a bit of a sag afterwards. And the next potential sugar rush may be accompanied by a tough-to-swallow dose of economic medicine.
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