Near the start of the present bull market for U.S. stocks, an ultra-accommodating Federal Reserve pushed interest rates lower. In fact, 10-year yields tied to mortgages had journeyed to unbelievably low levels across a four year span; meanwhile, stocks rocketed to all-time records.
Today, we still have an ultra-accommodating central bank. And, historically speaking, interest rates are still exceptionally low. Yet the direction of those 10-year yields has been decidedly higher, ever since the Fed introduced “tapering” to the investing lexicon.
Of course, bull market advocates continue to relish a variety of “absolute” data points. For example, corporate profits are at record peaks, forward price-to-earnings ratios (P/E) of 15 are seemingly reasonable and the 10-year yield of 2.7% is far below its historical average. There are reasons to be concerned about directionality, however. Corporate profits are slowing, P/Es are climbing and the 10-year yield has catapulted 65% since May; the direction of these trends may be more critical than the “absolutes.”
Consider the emerging growth story of the previous decade. Investors willingly paid a 25% premium to own up-n-coming economies like China because of double-digit or high single-digit economic expansion. As China’s economy slowed from 10% to 9% to 8% to 7.5% over the past few years, investors punished the nation due to the potential of a “hard landing” slowdown; ironically, nobody seemed to give credit to the absolute growth levels; everyone became enamored by the idea that electronic money creation must eventually find its way into risk assets whereby the developed markets became more attractive. In fact, developed markets currently trade at a 20%-plus premium to most emergers.
To further illustrate the notion of directionality, SPDR S&P China (GXC) had fallen nearly 20% between January and late June of this year. Investors began to speculate that China’s economy was rapidly deteriorating from 8.0% GDP expansion to a year-end level below 7%. Even worse, a liquidity crisis in the banking sector seemed to be taking root. When the dust settled, GXC’s prospects and economic data began to improve. Perhaps 7.5% was about as low as GDP would go after all. What’a more, Premier Li Keqiang pledged to never let China’s economy grow at a rate slower than 7%. It became a “line in the sand” moment where investors seemed to sense that Chinese leadership would enact stimulus measures if necessary.