One Market To Rule Them All!

‘One market to rule them all, one market to intimidate them, one market to bring them all down and in the volatility bind them.’¹

Sauron may well have uttered those words, as anyone that understands the bond market will know the power it wields. For a more earthly anecdote we can look to words from Bill Clinton’s chief strategist James Carville who famously said ‘I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a 0.400 baseball hitter. But now I want to come back as the bond market. You can intimidate anybody.’

Unless like me, and you have been diligently sticking to your New Year’s resolution of less screen time, you may know that the principal macroeconomic event causing fear in the stock markets recently, is the increasing cost of US government debt (also known as government bonds).

Bonds are issued by a government to support public spending. Bonds generally include a commitment to pay periodic interest, known as the coupon or yield, and to repay the face value on the maturity date. What is particularly important to note is that bond prices are inversely correlated to their yield. As in, should the market value of a bond fall (i.e. investors are only prepared to pay less than before) then the effective yield paid rises (as yield is paid as a fixed percentage of the original higher bond value at issue).

What we are currently seeing is less appetite for US government debt, which is a reflection of the broad sentiment for future US economic performance, with valid concerns at the fore right now in relation to the impact of Donald Trump’s stated intention to raise tariffs on foreign imports, which would likely raise US inflation while reducing company profits amongst other negative impacts. On the flip side, in time the tariffs may be beneficial for the US economy, however the journey to the sunny shires will be arduous depending upon the direction chosen by the incoming administration.

10 year bond yields have risen to 4.76%, their highest since August 2007 and those around at the time may well remember what followed became known as the Great Financial Crisis (GFC). However on a positive note (of sorts) it should be noted that the major stock markets did not start trending down until six or so months after August 2007, as by then the higher rates were starting to show their impact upon company debt repayments and profits for example. It may also be the case that bond yields are ‘normalising’ as interest rates were at historically low levels until relatively recently, and are now more closer to the average for the three decades preceding the GFC.

On a further positive note, when looking back at more recent bond yield volatility we can see an average timeframe during which they rose of about four months, after which the S&P500 began rising again. The latest bout of bond turbulence may end soon, if recent bond history where yields rose notably (ignoring the extremely unusual pandemic peak volatility in 2020/21) is anything to go by;

July 2016 —> December 2016 (5 months) – S&P then rose!
Feb 2022 – June 2022 (4 months) – S&P then rose!
July 2022 —> October 2022 (3 months) – S&P then rose!
May 2023 —> October 2023 (5 months) – S&P then rose!
December 2023 —> April 2024 (4 months) – S&P then rose!
Latest: Mid-September (4 months in mid-January) – S&P to rise soon?

One crucial factor determining whether the S&P500 will begin rising again soon is the coming fourth-quarter company earnings’ report season that is upon us. The expectations are high according to a recent Bloomberg article² with reports expected to show that the resilient US economy increased the earnings of the companies in the S&P 500 by 7.3% during the fourth quarter from a year earlier.

That’s the second highest pre-season forecast in the past three years, and according to Bloomberg ‘it threatens to put equities on a shaky footing if the results — or the outlook for the months ahead — fall short.’ Fourth-quarter earnings season officially begins this Wednesday, led by financial titans JPMorgan Chase & Co., Citigroup Inc. and BlackRock Inc.

On a broader positive note. Jan Hatzius, Goldman Sachs’s chief economist, expects the US economy to grow at a 2.5% rate this year, with the effect of Trump trade policies ‘small and largely offset by other factors’. Many forecasters agree, yet their caveat is that all bets are off if Trump really does intend to keep his promises. For various reasons, both his supporters and his critics consider that unlikely.

To wrap up, in the next month or so we may well have a better idea of the near term broad direction of stock markets. With continued strong earnings, a positive outlook and moderated plans by the incoming administration, we may well see a continuation of the exceptional performance of the US stock markets.

To return to the world of J R R Tolkien, we may be heading for Mount Doom, where the  One Ring was forged by Sauron, and the only place at which it could be destroyed. Whether Donald Trump will play the part of Frodo Baggins or Gollum is immaterial, as the One Ring must be destroyed to undo Sauron’s power and for him to be finally vanquished. Only then can we know if the warm and pleasant Shire is safe to return to.

¹ Credit to J R R Tolkien for the immortal words of inspiration from the Lord Of the Rings; ‘One Ring to rule them all, One Ring to find them, One Ring to bring them all and in the darkness bind them.’

² Source.