Oh my. The global bond bubble inflating right now is unleashing the conditions for the US stock market to melt up in the last quarter of the year.
Think I’m crazy?
This Wednesday will be an auspicious day in Europe. Germany is about to auction 30-year bonds that pay no income.
Yep. Any buyer will be guaranteed to get nothing for three decades.
How that makes sense is one of the wonders of modern finance.
Negative-yielding debt is like a virus, infecting and spreading through capital markets the world over.
It does put the spotlight on the US right now. The US government bond market is one of the few left where bonds pay an income stream.
A million dollars for an American retiree might get you about US$20,000 a year. It’s pitiful, but it is there.
That income stream is at great risk of disappearing altogether…
US bond yields could go negative
There doesn’t seem to be much stopping a tidal wave of money continuing to pour into US Treasuries to get what little revenue is left in government bonds.
Consider that the world’s third largest pension fund is in South Korea.
The Financial Times reports that it plans to double its holdings of foreign assets over the next five years.
There are two immediate consequences of this potential outcome.
The first we’ve floated before — it makes Donald Trump’s fiscal policy look sustainable. There isn’t a ‘bond vigilante’ in sight.
That’s one reason why Señor Trump is able to float the idea of cutting more taxes in America, despite the fact that he is running epic deficits. America’s federal debt is now over an astonishing US$22 trillion.
What’s another trillion to buy Greenland?
US stocks are cheap — on one measure
But it’s the second factor — around the potential for US yields to go negative — that matters most to you and me right now.
It’s the potential to drive Americans into the stock market en masse in a desperate hunt for growth. The conditions are there for this to happen.
Consider that the American stock market currently trades on an earnings yield above 5%.
This is not a dividend or income yield. But traditionally, stocks are considered ‘cheap’ when this figure is much higher than the 10-year bond yield. That figure is currently 1.56%.
Point being: It looks like a much better deal to buy US stocks than US bonds currently.
There’s no guarantee this will happen, of course. But the idea that US stocks can’t go higher from here is not necessarily true.
And imagine for a moment that the trade war is resolved or called off. You could easily see Americans pouring into the market on this basis alone.
But it’s a brave trader who positions for anything Donald Trump might or could do.
That means the next earnings round from the US market is going to be a big one.
And it won’t get any bigger than what Amazon, Apple, Alphabet, Microsoft and Amazon (the ‘Big Five’) report.
These have driven the bull market since 2009 and are holding the market near new highs.
The Economist ran some numbers around these guys recently. US technology firms account for more than a quarter of the value of America’s stock markets.
The Big Five account for 12% of pre-tax profits for non-financial firms in the US.
You could argue there’s more growth left in these old dogs. Apple is going to spend US$6 billion to join the streaming wars and take on Netflix and Disney. It now has a credit card.
But are these initiative going to be enough when the iPhone appears to have reached saturation? The only big market really left is China and Apple is not winning there.
We know Google and Facebook are banned in China.
Is it possible the Chinese authorities might allow them in as a concession in the trade war?
Could the US inflate from this?
It’s a thought, though probably unlikely.
Perhaps it doesn’t even matter for the moment. It might just be that Americans buy stocks regardless in order to escape the zero world of the bond market.
Here’s another thing to watch: The lower interest rates sweeping America make a refinancing boom likely as US mortgagees lock in a lower monthly repayment.
There are already signs of this happening.
But it does make me wonder: Lower rates will also make margin debt less expensive as well. Could the Fed repeat the mistake of the 1920s?
Back then, low interest rates sent Americans buying stocks on margin. This inflated the biggest boom in history at the time.
My take for today: When it comes to America, watch bond yields and margin debt. It could be an explosive cocktail.