When interest rates decline, bond prices go up. This means they reward investors even more than the interest payments would suggest. By and large, this has happened for the past 30 years.

Most people simply expect bonds to march ahead, pay out interest, and earn a little capital gains as well. But here’s what most folks in the mainstream aren’t telling you.That’s going to be hard to do today with rates so low.

Today, interest rates are so low, they can’t really go lower. So bond prices can’t rise, putting a mathematical end to a 40-year bond bull market that started in 1981 when interest rates peaked.

What’s more, the Fed’s primary weapon to fight inflation is to raise interest rates, again meaning bond prices would go lower. The central bank has already indicated it will do just that as soon as next year.

(In another scenario, the Fed could do nothing and let inflation run wild. Neither is a good outcome for income investors.)

Bonds have been around in some form for a long time, much longer than the U.S. stock market. So we can look back much longer in history at the bond yield of the world’s leading economies. And today, you’ll see bond yields are at roughly 800-year lows.

We simply can’t expect the bond bull market to continue.

 

 

You may also notice in the chart above that the bond bull market began in the 1980s, right when things were starting to trend into Great Moderation range.

Is that a coincidence? Perhaps. But it’s possible that investors expected the “quiescent” economy to continue and were willing to accept lower rates on bonds they now saw as less risky.

In other words, today, it looks like we’re at an important inflection point in the relationship between stocks and bonds.

Still, the conventional wisdom in the financial industry is to own both of these asset classes as has always been recommended.

Many people simply expect that the 60/40 portfolio will keep making a “safe” 7% or 8% annual return in the years ahead but that’s based entirely on the faulty premise that the returns of the past 30 years will continue in the future.

And the thing is, we’re already seeing the conventional wisdom might be outdated and mathematically impossible with the 10-Year Treasury at 1.5%.

Still, the entire retirement planning and investment industry is based on the past 30 years of stocks and bonds doing the same thing they’ve always done…

I’m here to tell you it can pay to think differently.

 

Market Data

 

  • The decline in stocks on Friday likely triggered a Dow Theory sell signal in the Dow Industrials and Dow Transports.
  • Share buyback announcements hit a record this year.

 

 

  • Forget margin debt. Retail investors are taking out personal loans to trade stocks. This is not going to end well.

 

 

  • We are past “Peak Fed” for this cycle.

 

 

  • Last Monday’s session saw one of the best breadth days in the history of the S&P 500. It’s unusual that it occurred so close to a new high. By late last week, there was a large deterioration in medium-term trends, but still with nearly 90% of stocks above their long-term averages.
  • US milk futures tumbled in recent weeks amid ample supply.

 

 

  • Bitcoin held support at 30k.

 

 

  • There is a big gap in returns on equity (ROE) and valuations between the US and the rest of the world (ROW).

 

 

  • But the US outperformance may have peaked.

 

 

  • In recent decades, the Fed has not been able to raise rates above the natural rate of interest (r*). That’s why estimating r* is so important.

 

 

  • Higher US real yields relative to China’s economic surprise index point to a recovery in the dollar and a continued decline in Gold and Silver this summer.
  • We’ve got a head-and-shoulders formation in Bitcoin.

 

 

  • The FX Pain indicator from Citigroup is showing heavy short positioning against the U.S. dollar. If markets follow through like they have after other periods during the last 15 years, the dollar should rally, causing problems for gold, commodities, and emerging markets.
  • Last week, we started to see more pronounced divergences in some of the indexes, despite the indexes themselves trading to new highs. There are some negative signs for several commodities, as well, especially if the dollar ‘pain trade’ follows through like it has over the past 15 years.
  • The average time it takes to recover your money after a 20% stock market correction. It’s 1,500 days or approximately three years.

Here’s the overall data since 1960:

 

 

U.S. stocks are extremely overvalued. The star in the line-up is the “median P/E” data from 1964 to present. Click on the link to see the chart.

  • Bottom line: A 48.6% decline to get stocks back to what is considered “fair value.”
  • As a target, that’s 2,160.91 in the S&P 500 Index. That’s a decline of more than 2,000 points from where the S&P 500 sits today (north of 4,275). Will that shake a few investors out of the buy-and-hold tree?
  • A 32% correction gets us back to “overvalued,” or the 2,858.78 level on the S&P 500 Index. Both offer better entry points vs. today’s level. In the end, fundamentals will win out.

The other half of the problem is the bond market. If you take corporate bond yields and factor in inflation, the current yield is below 0%. Negative safe money returns are not safe money.

  • Total margin debt at the end of May 2021 reached a record high of $861.63 billion.

 

 

  • Margin debt is very high. Investors are leveraged up. This means risk is high.

 

US Economy

 

  • Half of the recent homebuyers made a downpayment of at least 20%.
  • The US is increasingly facing housing shortages.
  • Pay has been rising the fastest in low-wage sectors.
  • Credit Card spending has been above pre-COVID levels.
  • Retailers now wield more pricing power than they have in years.
  • Spending patterns are not back to “normal.”
  • New COVID cases continue to trend lower.

 

 

  • Sources of retirement income in the US:

 

 

  • Existing home sales continue to lose momentum, with the May figure nearing 2016 levels.
  • Home prices are soaring, and inventories remain depressed.
  • The Richmond Fed’s manufacturing report topped market estimates as new orders surge
  • Manufacturers are rapidly boosting wages, as the hiring plans index hits a record high.
  • The “supplier delivery times” index is still extraordinarily high but appears to have peaked, which is also the case in other regions of the country.
  • The “backlog of orders” index has also peaked.
  • But inventory declines have accelerated.
  • Price indices are peaking as well.
  • Bosses are at work, but workers have not returned yet.
  • Air travel continues to rebound, putting pressure on understaffed airlines and TSA.
  • Semiconductor delivery delays are worsening, pushing chip prices higher.
  • Home price increases have accelerated in many economies.

 

 

  • US property taxes by county:

 

 

 

 

  • The Markit Manufacturing PMI hit a new record, pointing to exceptionally strong growth in US factory activity.
  • Neither supply chain bottlenecks nor price pressures show signs of abating.
  • Trucking rates appear to be peaking.
  • The massive revision in the nation’s industrial production index shows that the trade war did more damage to output than previously thought.
  • After years of underinvestment, CapEx is expected to rebound, boosted by strong corporate earnings.
  • Loan applications for house purchase are now at 2019 levels, suggesting that the pandemic-driven surge in housing activity is ebbing.
  • New home sales remain elevated but are moderating.

 

 

  • The inventory of new homes for sale (measured in months of supply) climbed in May.
  • The median price of new homes sold hit a record high.
  • Just as we saw in the U. Michigan report, the HP S-CS data show consumers increasingly uneasy with buying a home or making other major purchases. This trend is due to rapid price gains.
  • US birth rates are collapsing and are now only slightly above death rates.
  • Supply-chain bottlenecks are still at extreme levels, with the situation worsening this month.
  • The share of companies reporting rising prices remains near extremes but appears to have peaked.
  • Consumer confidence continues to improve. Americans are now almost as comfortable with personal fiances as they were before the pandemic.

 

Thought of the Week

 

“Your time is limited, so don’t waste it living someone else’s life. Don’t be trapped by dogma – which is living with the results of other people’s thinking.”

–Steve Jobs

 

2 Pictures of the Week

 

 

The horizontal lines are straight and parallel.

 

 

 

All content is the opinion of Brian J. Decker