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Don’t Expect the Bond Selloff to Continue

Slow growth will continue to keep long term rates down


What’s been unusual about 2013, at least until now, is that the stock market hasn’t had any major reversals. That’s not how previous years have played out. Despite the historic bull market, the S&P 500 had major drops in 2010, 2011 and 2012. Now we have a modest one: Measuring from the intra-day peak on May 22nd to Thursday’s low, the S&P 500 lost 5.27%. That’s the biggest break all year.

Here’s what’s happening. Since May 2nd, long-term interest rates have gapped up significantly. But what’s interesting is that shorter-term rates (inside of one year) haven’t moved much at all. The yield curve is essentially flat out to one year. If anything, short rates have edged slightly downward in the past three months.

One reason for the higher long-term rates is that the economy seems to be improving. The housing market, for example, is much better, and consumer confidence is on the upswing. With the improved economy, traders believe that Ben Bernanke and his pals at the Fed will ratchet down their bond-buying spree. “Taper” is the new buzzword on the Street.

I have to explain that moves in the bond market often foreshadow moves in the stock market. Usually, it’s by a few months, but sometimes it’s only a matter of weeks. Think of the two markets, stocks and bonds, as being in constant competition with each other for investors’ dollars. In just a few days, the yield on the 30-year Treasury has climbed from 2.8% to 3.3%, so that’s tempting to some folks who are getting a measly 2% yield out of the S&P 500.

Simultaneously, we’ve seen a gigantic boom in the Japanese stock market as the yen has plummeted against the dollar. The authorities in Japan are determined to boost their economy by getting some inflation going. I can’t judge if this will work, but their stock market responded. From November 13th to May 22nd, the Japanese Nikkei soared 80%. That’s an astounding gain. Since then, however, the Nikkei has given back 17%. The extreme volatility of the Japanese market seems to be causing some unease in the U.S. market.

After getting crushed by the dollar for several months, the Japanese yen finally struck back in a big way on Thursday. I suspect that this is traders anticipating a weak jobs report on Friday and therefore more aid from the Fed. The stronger yen is good news for AFLAC (AFL), but I’ll stress that I like AFLAC because of its business and low valuation, not as a backdoor play on the yen. AFLAC remains a good buy up to $57 per share.

Despite the downturn in the bond market, I don’t believe it will last very long. While the economy is better, it’s still far from strong, and all the talk of the Fed’s tapering is premature. Frankly, I don’t see the Fed taking its foot off the pedal for the rest of this year. Expect to see bond yields go back down, although not to the mega-lows from last summer. In fact, bond yields have already dropped since their peak last Friday. I think the 10-year yield will soon drop below 2% again.

My advice to investors is to ignore any short-term market fluctuations. The next big event for us will be Q2 earnings season. We’ve now passed the first-quarter earnings season, and there are only three weeks left in the second quarter. If the analysts are right, we’re going to see even better earnings growth for Q2

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