stocks vs. bonds when interest rates are rising (ii)

yesterday’s post: bonds

To summarize yesterday’s post, when interest rates are rising, newly-issued bonds bear higher coupons than ones issued in the recent past. Older bonds look less attractive, because they provide less return.  So they have to go down in price until they’re trading at equivalent returns to new ones.

Other than inflation-indexed bonds, Treasuries have no defense against this.

What about stocks?

Here the issue is a bit more complicated.

Let’s make the useful, and more or less correct, assumption that stocks and bonds are in equilibrium before rates start to rise.  If so, if bonds get cheaper, stocks will also have to get cheaper in order to compete for investor money against now-higher-yielding bonds.

This means rising rates puts downward pressure on stocks, too.

But stocks do have a defense.  It has to do with why rates are rising.

In most cases, rates begin to rise when either bond investors or the Fed sense incipient inflation that threatens to erode the purchasing power of money.  This is what triggers the impulse to raise rates.  Since in advanced economies, inflation is always an issue of wage inflation, its early warning signs are that the economy is reaching full employment and/or wages are beginning to rise at an accelerating rate.  In the US, that’s where we are now.

But more workers employed and wages rising at a healthy clip imply that consumer spending is likely to rise at an accelerating rate.  This implies accelerating profit growth for, in sequence, retailers, their suppliers and the providers of capital goods to both retailers and suppliers.  To the extent that a given stock market represents the local economy (which about half of the S&P 500 does), profits of publicly traded companies will start to go up at an unexpectedly sharp rate.

Rising profits create upward pressure on stock prices that serves as at least a partial counter to the downward pressure created by rising rates.


A second issue that will affect stocks directly is how the combination of inflation and higher rates affects the local currency.

If the currency falls, which is the most common case, export-oriented or import-competing companies will have the best results.  Purely domestic firms, and domestic firms that use foreign inputs, will fare relatively poorly.

If the currency rises, the opposite will most likely happen.

the S&P 500 in past times of rising rates

In the US in the past, the upward pressure from rising profits and the downward pressure from rising interest rates have most often neutralized each other.  There have certainly been diverse sector and industry performances, based on currency, technology, government fiscal policy and the overall state of the world economy.  So there have typically been substantial outperformance opportunities even in a sideways market.  But the overall market tendency in the early year or so of rising rates has typically been sideways, not down.


Tomorrow, REITs.



Veterans Day …and my birthday!

Given that way back when I served in the 101st Airborne, it’s a double holiday for me.

…a post nevertheless.


Yesterday was Day 2 of the President-to-be Trump era.

S&P 500 gains were more modest than on Day 1, but the general pattern of trading was similar.  Action continued to be “conceptual” in nature, that is, industries that Wall Street thinks will benefit from an end to Congressional gridlock generally did wellIndustrials and Basic Materials, for example.  Both parties have long favored amped-up infrastructure spending, but Republicans had previously blocked any initiatives.  We won’t know what Democrats would do were positions reversed, but with Republicans in control of both houses any attempt to ape their past anti-Obama behavior will prove ineffective.

Financials continued to outperform strongly, both on the idea that finally getting fiscal stimulus will free the Fed to alter its super-low interest rate stance.  The market also seems to believe that some restrictive provisions of Dodd-Frank will be removed come 2017.  Whether this is good or bad remains to be seen (for what it’s worth, seeing that no one has gone to jail and the same clowns who caused the financial crisis are still in charge, my vote is “bad”).  If some shackles come off, however, bank profits for a while will be higher than previously thought.  (Note:  despite my just-expressed distain, I own JPMorgan Chase.  I guess I’m a Wall Streeter at heart.)

Healthcare was up as well, on the idea that the industry will have greater pricing power under Republicans.  Healthcare firms also generally pay corporate tax at the highest rates–the reason inversions have been so prominent in this sector.  Tax reform would presumably benefit these companies more than others.

Yesterday also saw sharp losers.  Telecom, Utilities and Staples were all down by over -2%.  IT came close to that mark, at -1.8%.  IT seemed to me to suffer from serious derivative-led selling.  Don’t ask me why.  The only sense I can see in the rest is that the US$ has begun to rise, potentially lowering the profits from Staples.  The idea that rates will be rising for sure, and faster than under a Hillary administration, is behind the weakness in bonds, Utilities and possibly Telecom as well.

Energy took the day off.


A closing thought:  if we were to roll back the clock by a week, liberals could have imagined that when Hillary won, disgruntled Trump supporters might organize anti-Clinton demonstrations in right-wing hotbeds.  These protests would have been labelled as typically Trumpish, and disgraceful.

As regular readers will know, I’m not a fan of Trump.  It seems to me, however, that the most effective way to influence Mr. Trump is to boycott the products bear his family name, not to cast doubt on peaceful transition of power to the election winner.


looking at day one of the Trump-era stock market

initial reaction

Very early yesterday morning, S&P 500 index futures had fallen by 5% as the stock market gave its first verdict on the election of Donald Trump as the next president of the US.

That Mr. Trump’s surprise win should be met with initial selling isn’t itself so shocking.  Trump himself had offered a Brexit metaphor to describe his potential victory. (In trading the day after the Brexit results were announced both the British stock market and the pound collapsed.)  And an op-ed in yesterday’s UK Guardian, for example, describes Trump as having ” a folly so bewildering, an incompetence so profound that no insult could plumb its depths” as well as being “the least-qualified candidate of all time.”

What’s noteworthy is that, unlike the Brexit case, the selling dried up in short order.

regular trading

During regular trading yesterday, the S&P initially declined by almost a percent …before reversing course and ending the day up by 1%+.  Government bonds declined sharply.  The dollar was basically unchanged.  This happened even though earlier in the week Wall Street rallied on the idea that Hillary would win.

sector breakout

The sector pattern of trading was also revealing:

–the largest gainers, according to Google Finance, were Healthcare (+3.3%), Materials (+2.6%), Financials (+1.6%), Industrials (+1.6%) and Energy (+1.0%)

–relative losers were Utilities (-2.4%) and Staples (-1.0%).  Real estate–part of the Google Finance financials–was down by about 2%

–looking more closely at the Energy sector, big multinational integrateds rose more or less in line with the market, while smaller exploration firms and oilfield services companies (the last being the rocket fuel of the Energy sector) made more substantial upward progress.

economic underpinnings

Led by Wall Street, global markets shifted very quickly away from concern about Trump’s checkered business career and his white supremacist views.  They began instead to explore the implications of the likelihood that legislative gridlock is unlikely to continue in Washington now that one party controls both the Oval Office and both houses of Congress.

On the most general level, this likely means that Washington will approve a large infrastructure spending plan early next year.  This will have two consequences.  It will create demand for labor at a time when the country is already at full employment.  This means that wage growth, which already looks to be expanding at an increasing rate, will continue to accelerate.  At the same time, the presence of fiscal stimulus will remove some of the need for the Fed to keep interest rates at intensive-care lows.  Both aspects imply that short-term interest rates may begin to rise at a more rapid than anticipated clip.

The idea of spending on roads etc. means higher demand for basic materials and for construction machinery.  Rising rates are bad news for government bonds, and for bond-like securities such as REITs.  So, too, is the possibillity that wage-driven inflation may emerge as an issue as soon as 2017.  On the other hand, rising rates tend to be good for large banks, which were among the best performers yesterday.

In addition,

–income tax reform that lowers corporate rates (good for full-tax payers like healthcare companies) seems likely next year.  Republicans seem particularly eager to repeal/replace Obamacare, which would arguably be good for healthcare providers

–the oil and gas industry is one that has been traditionally in the Republican camp.  Trump has promised to stimulate oilfield activity.


Let’s see what today brings.













active managers’ assets shrank last year

The Financial Times reported on Halloween the results of a study by Willis Towers Watson done for Pensions and Investments (how’s that for complicated?) showing that the assets under management of the top 500 fund management firms shrank in 2015 for the first time since the Great Recession ended.  The decline was greatest for Europe-based managers.

Several factors appear to be at work:

–sovereign wealth funds, especially those sponsored by Middle Eastern oil exporters, have been cashing out to fund expanding budget deficits

–large traditional pension providers are taking assets away from third-party money managers to handle them in-house (this could turn out to be just as disastrous as do-it-yourself dentistry or knee surgery, if the pension administrators try any form of active management)

–flattish markets and a strong dollar, reduced the d0llar value of non-US assets, resulting in slight investment losses.


In addition, within the industry market share is shifting:

–the top 50 firms increased assets; the other 450 lost enough to more than negate those gains

–assets shifted from high-fee active management to low-fee passive alternatives.


My thoughts:

–not a good time to be a small or mid-sized asset manager, since operating profits are contracting both from lower assets under management and from lower fees on those assets.  This implies to me that greater numbers of minnows will sell out to whales.

–although I can’t see into the inner workings of asset managers any more, my experience is that firms cut their younger, lower-cost (but considerably greater upside) professional employees in order to preserve the income of their higher-paid longer-tenured colleagues.  This is, I think, a recipe for disaster    …and will worsen the position of smaller firms.  More reason to expect consolidation.

–I have little conviction on how this development might affect active management.  My inclination is to think that markets will become less efficient, meaning a better change for you and me to outperform.  Another possibility, though, is that the door will merely open wider for computer-driven investment strategies.  I don’t think this necessarily lessens the chances for you and me.  But it may mean that we will have to key off market indicators that we reckon will have appeal to algorithmic investors, rather than those that will motivate humans.