market rotation continuing

important road signs: a recap

The 10-year Treasury peaked at a yield of 0.52% in the middle of last summer. The benchmark bond then began a slow, steady decline (meaning the yield rose) to 0.93% at yearend–a 40 basis point change in six months. The 10-year hit 1.36% this morning, or a 43 bp rise in yield in seven weeks.

The Russell 2000, a measure of the health of US-based companies making and selling bread-and-butter things to US customers, was in steep decline relative to NASDAQ from the day Trump’s big tax cut for his ultra-wealthy boosters went into effect until the November election. Since then the R2000 is up by 39% vs. NASDAQ’s 19% rise.

my interpretation

For bonds, I’m mostly making up numbers. Let’s say a return to a “normal” economy means US yearly GDP growth of 2.0%, with inflation of 1.5%. And let’s posit that bond holders require a real (after-inflation) yield of 2%. That translates into a nominal annual return of 3.5% for lending money to the federal government for a decade. At a nominal yield of 52 bp last July, Treasuries were locking in a real loss of 1% a year for buyers at that point. Sort of like agreeing to pay a bank 1% per year to store your money.

In my view, this was real despair/panic and was related to the US experience with the pandemic.

A second point: on my numbers, we’ve only begun to normalize interest rates. There’s lots more to come.

As to stocks, my take is that the stock market understood much more clearly than the average American how deeply economically destructive the major policies of the Trump administration were. From January 2018 through October 2020, NASDAQ rose by 59%, while the R2000 was barely in the black at +2%.

I take the reversal since as purely conceptual–that is, not based on concrete evidence that the economy is getting better but simply by the notion that what I’ve called the capital flight trade is over and that the worst of the economic damage is behind us. My sense is that the pandemic is a net neutral. We’ve found that the Trump administration actually did much less than its press releases claimed. On the other hand, the vaccination and reopening schedule seems to no longer be vaporware and to be gathering momentum.

More tomorrow.

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