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Stock Bear Roars, Bond Market Stabilizes

Stock Bear Roars, Bond Market Stabilizes

May 20, 2022

Two different stories are being told by the stock market and the bond market this week. 

Stocks as I write this have officially entered bear market territory, down 20% from their highs earlier this year.  Attribute the stock sell off to general angst over so many unknowns – inflation, war, inflation, supply chain disruptions in China, recession chatter, inflation, did I mention inflation? 

Meanwhile the bond market has stabilized over the past 2 weeks and is rallying a bit as stocks fall.  A sign of normalcy. 

The bond market is clearly saying “we don’t believe this inflation story has legs”.   There is no way on earth that the 10 year Treasury would be selling at an interest rate of 2.78% (where it is right now) if market participants thought that inflation over the next 10 years is going to remain at today’s escalated levels.  The bond market is essentially forecasting that inflation will fall back considerably and stabilize at or near the 2% or so rate that we are accustomed to.   The bond market is therefore expecting that a) supply chain issues will work themselves out in time and/or b) demand will slow and take the pressure off.  Note that “demand will slow” could be a euphemism for recession, but few economists are anticipating a recession in the near term, and most will suggest that if we do experience one, it will be mild.   I agree.  For now, we have record low unemployment, rising incomes, strong balance sheets, and aside from a few speculative areas of the stock market (and crypto which is by its very nature a speculative bubble) there are few out of control excesses such as typically cause severe recessions.  The bond market overall seems to have made its adjustments (down 8% or so on the year) and is content to hover at current levels.  

The stock market on the other hand, seems to be losing its grip on reality.  This is typical after such a sharp selloff as we have seen over the past several weeks.  When you have a sudden and severe fall in stock prices, many technical pressures tend to exacerbate selling pressure for a short period of time.  Investors may face margin calls or other “forced selling” pressures which have nothing to do with the long term fundamental value of companies themselves.  Such “technical” selloff pressures tend to be very short lived.  We experienced this effect in 2018 and 2020 and in both cases the market dropped sharply with very high volatility, only to recover and stabilize as the speculative players were forced out.  We are getting to where the stock market is pricing in the reality of a recession – when in fact very few economists are yet calling for a recession to happen. While no one can predict where the bottom of these events will be, and economists are notoriously bad at predicting the future – I still think stocks appear more attractive as an investment opportunity for a patient long term investor than at any time in the last 2 years. 

The good news for investors is that when predictions of the bond market and the stock market diverge, it is usually the bond market that proves the more sober and accurate forecaster.   Perhaps because it is less exposed to the influence of speculation, leverage, and similar excess.