Earlier this year, the bond market freaked out when Ben Bernanke hinted that the easy-money party would be coming to an end. The yield on the three-year Treasury spiked from 0.3% in May to nearly 1% after Labor Day. Ben was clearly shocked by the market’s reaction to his comments, and he’s been careful to walk back, or “clarify,” those remarks. Either way, the Fed hasn’t come near tapering since. But now Bernanke is nearly out the door, and Janet Yellen will soon be taking over. The latest conventional wisdom is that tapering will be coming this March. We’ll see about that.
But the bond market has been in a sour mood again. On Thursday, the yield on the 30-year Treasury closed at 3.92% which is its highest yield since August 1, 2011. But here’s the key point: The recent sell-off in the bond market is quite different from what we saw this summer. Back then, it was the middle part of the yield curve that saw the biggest rise in rates. This reflected the belief that short-term interest rates were going to rise sooner than folks had expected.
This time, the rise in rates has largely been at the long end of the curve. In fact, the middle part of the curve hasn’t moved very much at all. The three-year is hovering just over 0.6% which is well below its peak from September.
This is an important change in the market’s attitude, and I think it’s because the current bond market downturn is due to a belief in stronger economic growth rather than an imminent rise in interest rates. Here’s the weird part. Lower bond prices may be specifically due to a belief that the Fed will hold down rates for a while more. In other words, the Fed is working to steepen the yield curve.
So what’s all this good economic news, then? Let’s review.
On Monday, the November ISM Manufacturing Index came in at 57.3. That’s the highest level since April 2011. Any reading above 50 indicates that the manufacturing sector is expanding. This was the 50th time in the last 52 months that the ISM has come in above 50. Let me be clear: That isn’t gangbusters, but it’s not bad.
On Wednesday, the Federal Reserve released its “beige book” report, which is a survey of the U.S. economy by region. On balance, the report was encouraging, and business activity seems to be picking up, although there are still pockets of weakness.
Also on Wednesday, ADP, the private payroll firm, said that 215,000 jobs were created last month. That was 30,000 more than analysts were expecting. Then on Thursday, the number of Americans filing first-time jobless claims fell to 298,000 which is the second-lowest number since early 2007. This report tends to bounce around a lot, so it’s better to look at the trend which has been heading in the right direction. It also appears that any side effects of the government shutdown have passed.
But the really big economic report is Friday’s jobs report for November. The non-farm payroll report topped 200,000, which is more confirmation that the economy is ramping up.
We got more good news on Thursday when the government revised its Q3 GDP report significantly higher. The initial report came in at 2.8%, but now the number crunchers say the economy grew by 3.6% last quarter. Over the last 30 quarters, that’s the economy’s fifth-strongest quarter. But one downside to the GDP revisions is that a good portion of that economic activity was restocking shelves, and not so much people buying stuff off those shelves. However, this was the third quarter in a row that economic growth has accelerated.
These encouraging economic reports aren’t much of a surprise to us. I’ve recently discussed how the rally has been led by cyclical stocks, and that’s usually a precursor of good economic news. By cyclical, I mean industries that are heavily tied to the economic cycle. When things get tight, folks keep buying toothpaste, but new houses? Not so much. Last Wednesday, the relative strength of the Morgan Stanley Cyclical Index reached its highest point since July 2011. For the last 16 months in particular, cyclical stocks, consumer discretionaries especially, have been grabbing the lion’s share of the market’s gains.
I’ve often noted that the current rally is the most-hated rally in Wall Street’s history. OK, perhaps that’s a bit of an overstatement. Still, I suspect that a major reason for this hatred isn’t that the bears haven’t seen drops; it’s that they have. Consider that during the current rally, which began in March 2009, we’ve seen separate drops of 5.6%, 5.8%, 6.4%, 7.1%, 7.7%, 8.1%, 9.9%, 16.0% and 19.4%. Every single one has led to a new high. Every single one.
What’s also interesting is the breadth of this market. The top 10 point contributors in the S&P 500 have accounted for 18% of this year’s gain. In 1999, that number was 65%. The tech bubble was created by a very small number of stocks. That’s not what’s happening now. Nor have we run out of room. Since World War II, the S&P 500 has gained 20% or more 18 times. The following year’s gain has averaged 10%.