Morning Notes — Better than Feared

On Wednesday, we explained how ‘convexity hedging’ by banks and insurance companies accounts for most of the recent momentum in bond yields. The virtuous cycle will likely continue but momentum/volatility will begin to decelerate as we near the ‘zero-bound.’ The Fed has said it won’t go negative, but the ECB said the same thing for years. You can guess all you want, but pricing models don’t guess and as you get closer to zero the models will reflect asymmetric risk. There will be only one direction for yields to go and that’s up, which means lower volatility.

We continue to think SPX levels below 2900 mark a very attractive entry point to add broad equity exposure. Bearish equity sentiment has yet to return to bearish extremes but our data lags by a few days. We’re also still comfortable applying an 18x multiple (low considering bond yields) on a ‘stressed’ 2020 SPX EPS estimate of ~$170, suggesting a valuation target of ~3050. And, if anything, the $170 feels too conservative…especially after another 24 hours of ‘better-than-feared’ coronavirus-linked preannouncements from AMD and SBUX.