The Canadian research outfit BCA Research seems to have second thoughts about the US bull market: (bold mine)
The speed of the yield jump is unnerving for stock bulls. Bond yields are rising much faster than profit growth. The broad market has run into trouble whenever the growth in yields has surpassed the growth in earnings. More serious equity pullbacks have occurred when this differential is negative 10% or lower, as is currently the case. This scenario has historically been associated with too rapid an increase in inflation expectations, which spells valuation and monetary trouble ahead. The current signal from this indicator is negative, as the differential is at its widest level in more than 20 years. However, it should be noted that inflation expectations are not problematic at the moment, and the very low starting point in yields reduces the indicator’s efficacy. Still, this gauge has a reliable track record, underscoring that capital preservation should remain of paramount concern.
Yes, capital preservation should indeed be anyone's paramount goal.
And volatile bond markets marked by rising bond yields are likely to continue, because of the unintended consequences from the US Federal Reserve policies of inflating a global bond bubble
Writes Dr. Ed Yardeni
The sharp increase in yields caused by the QE tapering talk suggests that the Fed's bond purchases inflated a big bubble in the bond market. As I’ve noted previously, the 10-year yield normally tends to trade around the y/y growth rate in nominal GDP. The jump in yields is normalizing this relationship. The Fed’s tapering talk has caused investors around the world to taper their holdings of bonds. That’s starting to poke holes in other bubbles as well, particularly emerging market bonds, currencies, and stocks.
To add to the above, increases in bond yields (10 year USTs) has coincided with slowing economic growth.
Also emerging markets and ASEAN markets are behaving like a periphery to the core dynamics.
The bond bubble has been underpinned by unsustainable accumulation of debt from government deficits, which I have been pointing out.
Writing at the Project Syndicate, economist, president emeritus of the National Bureau of Economic Research (NBER) Harvard professor Martin Feldstein warns of an upward trend of bond yields for the same reasons…
Although it is difficult to anticipate how high long-term interest rates will eventually rise, the large budget deficit and the rising level of the national debt suggest that the real rate will be higher than 2%. A higher rate of expected inflation would also cause the total nominal rate to be greater than 5%.
…as well as the risks of a comeback of price inflation
The greatest risk to bond holders is that inflation will rise again, pushing up the interest rate on long-term bonds. History shows that rising inflation is eventually followed by higher nominal interest rates. It may therefore be tempting to invest in inflation-indexed bonds, which adjust both principal and interest payments to offset the effects of changes in price growth. But the protection against inflation does not prevent a loss of value if real interest rates rise, depressing the value of the bonds.
Mr. Feldstein says that the current environment seems ripe for a crisis.
The relatively low interest rates on both short-term and long-term bonds are now causing both individual investors and institutional fund managers to assume duration risk and credit-quality risk in the hope of achieving higher returns. That was the same risk strategy that preceded the financial crisis in 2008. Investors need to recognize that reaching for yield could end very badly yet again.
Caveat emptor.
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