Reuters / Lucas Jackson
- Daniel Lacalle, chief economist at Tressis, sees a major disconnect between the narratives surrounding the stock and bond markets, as well as their recent price action.
- He also thinks it’s "very dangerous" for equity markets to rely as heavily as they currently are on the prospect of ultra-easy monetary policy — especially when the future path is so uncertain.
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Stocks and bonds are supposed to behave differently. After all, the incongruent relationship is meant to provide a hedge to investors that aren’t interested in bearing the turmoil that comes with one-sided exposure.
What’s good for stocks — positive economic data, increasing earnings and revenues, confidence, and an optimistic outlook — should theoretically be bad for bonds, and vice versa.
But right now, that’s not what’s happening. Both asset classes have been on a tear.
Stocks have seemingly been immune to those headwinds described above, hitting a series of new highs this year — although a recent escalation in trade tensions complicated matters somewhat. However, since the recent flare-up, they’ve recovered and are now back trading within a stone’s throw of all time highs.
Meanwhile, bond investors have been more attuned to signals of a global slowdown, with yields on long-dated Treasurys hovering near record lows. That indicates that traders are seeking refuge as they weigh a future that could be marred by a recession.
But if stocks are portraying the narrative that all is well, and bonds are behaving like we’re in deep trouble, which narrative is correct? Both asset classes are telling different stories, but are rallying in concert. What gives?
"Something does not compute," he said Macro Voices, an investing podcast. "It is impossible that the message that we receive from the bond market is the same one that we receive from the equity market, which is the opposite."
To Lacalle, the price action that’s playing out in the market is a paradox.
Despite recent stock-market hiccups, on a year-to-date basis equities have rallied and bond yields have plunged at a velocity that has him worried. He says one of these asset classes is behaving like an imposter — and he thinks he’s pinpointed the culprit.
"The bond market — more than $15 trillion of negative yielding bonds — is telling us a very high risk of disinflation, not deflation," he said. "And a very high risk of stagnation."
Lacalle continued: "The equity market is telling us there’s going to be QE no matter what."
This is where Lacalle sees a disconnect.
To the equity market, it doesn’t matter that second-quarter earnings season was blasé, and that macro data came in weaker-than-expected — quantitative easing is going to save the day. Lacalle says that thinking is inherently counterintuitive, but investors don’t seem to care. And what’s more, equities have been indiscriminant about pricing this idea into their current valuations.
"It’s also very dangerous to believe that central banks are going to take such an aggressive stance simply to maintain the trend of asset valuations," he added.
Bonds are reflecting the reality of a slowdown in global growth, so the reasoning behind their rally seems to be warranted, says Lacalle. On the other hand, equities are taking bad news and turning it into a rally.
This sets the scene for a potential sticky situation down the road. If central bankers fall short of market expectations, we may see a sharp, violent reversal of this trend.
Although pricing action may seem a bit disjointed at the moment, it’s best to keep the wisdom John Maynard Keynes bestowed upon investors quite some time ago: "The market can stay irrational longer than you can stay solvent."
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