Narratives always follow price.
Always.
One of the narratives I heard this year throughout the “melt-up” was that “the economy just isn’t as sensitive to interest rates as it used to be anymore.”
Bullshit.
Anyone looking at the dollar, Europe, emerging markets, retail stocks — basically anything outside of the S&P 500 — can clearly see that many leading areas of the real stock market have been behaving poorly precisely because of the impact interest rates (eventually) have on the economy.
We went through the fastest rate hike cycle in history, and to think interest rates don’t matter is beyond absurd.
The Role of Interest Rates
I often share clips of a lecture my father, Michael E.S. Gayed, did in the mid-1980s. My dad (may he rest in peace) worked on Bob Farrell’s team at Merrill Lynch at the time. Many years ago I stumbled on a VHS tape (remember those?) of him doing an intro course on Technical Analysis.
There’s one clip in particular that is highly relevant today when it comes to interest rates. He said:
“What is the bond market? The bond market is very sensitive to interest rates. Okay? What is interest rates? Interest rates is the heart, soul and life of the free enterprise system. Yes, we are technicians. Look at all these chicken bars. Okay? But interest rates is one of the indicators very, very closely watched by professional technicians.
“Interest rates is the soul heart, brain, life of the free enterprise system. You want to cause a Depression next week? Okay? Push interest rates to 500%. As simple as that. You push interest rates to 500%, an immediate collapse in whichever nation that starts that and it’s going to propagate, the Domino theory, into other free enterprise system, interrelated through international trade and so on and so on and so forth.
“You want to cause tremendous boom, the market will just 5000% 5000 will go to 5000, lower interest rates to -25 which means we’ll give you 25% if you borrow from us, but that will be a big expense of inflation.”
He’s right.
We can debate whether it’s a “free enterprise system” anymore, but the role of interest rates on the economy — on the heart soul and life of what drives activity — cannot be denied. Just because people don’t recognize there are lags doesn’t mean the causation is broken.
The Bottom Line
Some will argue that interest rates are not high enough. The fact that small-caps have gone nowhere is a tell that that’s not true. Some will argue that credit spreads being as narrow as they are means interest rates are not high enough. The fact that bankruptcy filings in the real economy are surging is a tell that that’s not true. We are in a high-risk juncture, and to think that the lagged effects of rates on the market hitting just around now should be ignored is wrong.
Conditions favor a tail event — let’s just hope it’s not a cardiac one for the stock market’s true heart — bonds.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
