Bond Prices are Extremely Oversold
February 23, 2021
The 5-year/30-year yield spread is currently priced to 161.3bps and approaching resistance at ~162bps. We remain intermediate-term bullish on the cyclical/value equity trade, but the slope of the yield curve looks extended at the moment and vulnerable to flatten back to 2015 highs of ~155bps. Notwithstanding a material break above 162bps, we prefer to wait for our favorite cyclical/value stocks to reach short-term oversold conditions (now overbought) before adding exposure. The S&P 500 Value Index (SVX) has more upside potential and expect a more durable outperformance vs the S&P 500 Growth Index (SGX) in the weeks/months ahead.
Pain trade: Super-large cap growth stocks (FAANG+) are ‘long-duration assets’ with a positive correlation to 30-year bond prices. Whether they know it or not, most investors are heavily overweight the group and markets have a tendency to go where they can inflict the most pain. In the near-term, we expect the group to bounce if yields fade from resistance as expected.
Inflation? We view the rise in bond yields to date more as an expression of economic confidence than inflation concerns. That’s the 6-9 month window where the market is focused. But consensus expects inflation numbers will fade as secular disinflation forces return later this year. Some disinflationary forces will return, but not the important ones. The past 12 years of global disinflation were partially caused by technological advancements, but more so by a series of cascading events starting with: 1) bank deleveraging in the wake of the 2008 financial crises; 2) China’s decision to de-lever with its 2012 change in leadership; 3) the resulting US-China trade war in 2018 and; 4) a global pandemic last spring. Unprecedented policy stimulus was added at three of the four events, US money supply is now growing at 25.8% and US consumer balance sheets (especially with the bottom two deciles) are the strongest they’ve been in more than 40 years.