Signals from the Bond Market

An important live event tomorrow night… how to interpret the Treasury Yield Curve… its current condition, and what it means for stocks

 

Before we begin today’s Digest, a quick note…

The wealth gap we started highlighting here in the Digest years ago has only intensified over the last 12 months.

As my colleague, Luis, pointed out on Saturday, in Q1 of 2021, the top 10% of households in the United States owned $70 for every $100 in household wealth. Meanwhile, the bottom half of households held just 2% of household wealth.

Much of this divide is due to is something that regular Digest readers know all-to-well – the Technochasm.

This is Eric Fry’s term for the way that massive profits from technology-related investments are creating an enormous economic distance between a small group of individuals who use technology as a financial tailwind…and everyone else.

This decade, it will be critical that you position your wealth in the right side of this Technochasm.

With this in mind, I want to alert you to a special live event tomorrow evening at 7 PM ET with Eric and Louis Navellier called the 2021 Tech Supercycle Summit.

They’ll be detailing the latest in the Technochasm… cutting-edge trends that are driving tech profits, such as artificial intelligence, autonomous driving, and the internet of things… and even several small but promising stocks that are poised to soar as the Technochasm continues exploding the wealth gap.

This is an important evening if for no other reason than understanding this massive economic fracture that’s dividing our society.

To sign up for free and join us at 7 PM tomorrow, just click here. We’ll see you there.

On to today’s Digest

***Wall Street is feeling bipolar these days

After some volatility in January and February, the S&P surged from early March through April. Hopes were that the world was returning to some degree of normalcy.

But then as inflation fears gripped investors, markets fell in May, trading sideways until mid-June.

But these concerns were short-lived as investors bought into the concept of “transitory inflation.” They pushed prices to all-time highs in early July…only to suffer a pullback in the wake of Covid-19 Delta variant fears.

Of course, last week, the bulls resumed control, pushing markets to an all-time high on Friday.

Phew…

With this volatility as our background, let’s turn to our technical experts and the editors of Strategic Trader, John Jagerson and Wade Hansen:

Financial news moves so rapidly these days that it’s easy to get lost in the noise…

At times like these, we think it’s helpful to take a step back and look at the bigger picture. Doing so helps us tune out the noise so we can focus on what is driving the longer-term trends.

The good news is…as we step back and look at the longer-term signals, they are telling us that Wall Street is not shifting gears to a bearish outlook. Instead, it is moderating its bullish expectations.

In today’s Digest, let’s dig into what John and Wade are eyeing that’s giving them this takeaway.

As importantly, they will explain an important market dynamic that you’ll be able to monitor going forward. This will provide you actionable insights to help you position your portfolio accordingly.

Let’s jump in.

***Understanding the Treasury Yield Curve, and what it’s telling us today

For newer readers, John and Wade are the analysts behind Strategic Trader. This is InvestorPlace’s premier trading service combining options, insightful technical and fundamental analysis, and market history to trade the markets in all sorts of conditions.

In their update last week, they highlighted a powerful way to evaluate expectations for economic growth – the Treasury Yield Curve.

From the Strategic Trader update:

The Treasury yield curve is a graphical representation of the yields of all currently available Treasuries – from short-term notes to long-term bonds.

Shorter-term Treasury yields are plotted to the left of the chart, and longer-term Treasury yields are plotted to the right of the chart, with the time until maturity represented along the X-axis and the yield each Treasury is generating represented along the Y-axis. You can see an example in Figure 1.

Figure 1 –Treasury Yield Curve

John and Wade explain how, usually, the Treasury yield curve will slope upward from left to right. This is because shorter-term Treasuries typically provide lower yields while longer-term Treasuries usually provide higher yields.

This makes sense – when investors buy a longer-term asset, they’re exposing themselves to greater inflation-risk. To compensate for that, investors demand higher yields.

***This normal-shaped yield curve doesn’t always exist

The slope of the yield curve can vary…sometimes dramatically. It can even invert.

Given this, the condition of this yield curve offers investors clues about what bond traders believe is going to happen in the economy.

Back to John and Wade for these details:

steepening yield curve generally indicates bond traders believe the U.S. economy is going to experience greater inflation (typically driven by strong economic growth) in the future, which leads them to demand a higher yield on their bond investments to compensate them for the additional risk they are taking.

flattening yield curve generally indicates bond traders believe the U.S. economy is going to experience less inflation (typically driven by weak economic growth) in the future, which leads them to demand a lower yield on their bond investments.

Sometimes, the yields flatten so much that you get an inverted yield curve – where the short-term Treasury yields are higher than the longer-term Treasury yields.

Inverted yield curves are a warning sign for the stock market because while not every recession has been preceded by an inverted yield curve, almost every inverted yield curve we have seen in the past 40 years has been followed by a recession.

So, what’s the current shape of the yield curve?

***From fear to enthusiasm to cautious optimism

John and Wade write that the yield curve gave investors its most dire warning back in early March. It didn’t fully invert – the 30-year yield was still higher than the yield on the overnight Federal funds rate.

But as you can see looking at the blue line in John and Wade’s chart below, the middle (or belly) of the curve had inverted.

Figure 2 – Treasury Yield Curve Comparison (Steepening)

Back to John and Wade for how to interpret this:

This told us that bond traders were extremely nervous about the economic outlook – thanks to the coronavirus.

But as we noted at the top of this Digest, as we moved later in the year, confidence rebounded.

Bond traders let go of fears that the global economy was doomed, and began selling bonds which pushed yields higher again.

Remember, when traders feel good about future prospects, they tend to rotate out of safe-haven investments, like bonds, back into higher-risk assets, like stocks, in order to increase their returns.

All of this caused the yield curve to steepen.

So, what’s happened since March?

Back to John and Wade:

As you can see in Figure 3, the yield curve has flattened a bit during the past few months – telling us that economic growth expectations have moderated.

Figure 3 – Treasury Yield Curve Comparison (Flattening)

Here’s the thing. The flattening we have seen isn’t all that dramatic, and most of it has happened at the longer-term end of the curve. Shorter-term yields have barely moved at all.

So, while it is certainly important to notice the flattening we’re seeing in the curve, it is also important to put it in context of where we were last year.

John and Wade then make a great point…

If you hadn’t seen the near-inversion in the Figure 2 chart, and the only chart you saw was the Treasury yield curve comparison in Figure 3, you would be thrilled to see how much more bullish the yield curve looks today than it did in March 2020.

***What’s the takeaway from all of this?

Expectations for economic growth aren’t as bullish as they were a few months ago. We see that from the reduced steepness of the yield curve.

But reduced expectations shouldn’t be confused with bearish expectations. Traders are still expecting solid economic growth.

So, what does it all mean for stocks?

Here’s John and Wade’s bottom line, which will take us out today:

We expect economic growth to remain strong and for earnings season to continue to surprise to the upside. Watch for more stock market bullishness.

Have a good evening,

Jeff Remsburg


Article printed from InvestorPlace Media, https://investorplace.com/2021/07/signals-from-the-bond-market/.

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