Research.LeutholdGroup

In the last few months, we’ve warned that Wall Street’s favorite security—the Federal Reserve Put—has been at least temporarily replaced by a novel derivative with a less favorable risk/reward profile: the short Fed call.

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With yields on the 10-Yr. Treasury finally breaking above 1.00% last month, the consensus has quickly evolved to the view that stocks and yields can continue to rise alongside one another for a while. Small Caps have shown a decisive performance edge during the recent episodes.

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When investors ponder the level of yields that might pose a problem for stocks, it’s invariably the U.S. 10-Yr. Treasury bond that’s referenced. That’s fine, but the middle part of the Treasury curve has had just as strong a relationship with stocks, historically, as have longer-dated bonds.

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The 2020 post-election stock surge looks and feels a lot like the 2016 “Trump Bump.” But, of course there’s a spoiler. The Biden Bump started with a Normalized P/E level about 30% higher than the one prevailing on election eve of 2016 (26.8x versus 20.5x, respectively). 

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The collapse of U.S. Treasury yields and the simultaneous end of the bull market has produced a new all-time record for the S&P 500, albeit under less-than-desirable circumstances.

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We’ve sometimes called the yield curve our “favorite economist,” so we were amused when some enthusiastic data miner in the Treasury market tried to slip us a cheap imitation in late November.

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We somehow missed this signal in January, perhaps because we were pre-occupied with so many other signs of “climate change.”

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While the collapse of Swiss government bond yields into negative territory was January’s bond market stunner, our “G7” composite 10-year government bond yield reached its own milestone when it closed the month below 1.0% for the first time in post-WWII history.

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We define four states of the stock-bond relationship based on the directions of stock price and bond yield movements; stocks fear tightening more than true risks, while bonds are more responsive to Risk-On and Risk-Off.

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Bond yields have declined 40-55 basis points in the past three months.

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GDP growth of 4.0% projected for 2004. Improved 2004 budget deficit projections a short term positive for bonds but eventually could be a negative.

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Rising stocks and still good economic news make third Fed boost likely.

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New inflation fears and strong economy contributing to higher yields. Fed may tighten in coming months to slow down this high powered economy.

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Wage inflation looked like it was finally taking off in October, but November's data showed a different picture, as four of the nine subsets (including Total Wage inflation) moved lower.

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Today, T-bills are yielding 3.20% and high quality commercial paper is yielding 3.40%. It may be useful to examine these rates in a historical perspective. Some may think these are just about the lowest short term rates in U.S. history. Well, not quite.

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We thought last month might be the end of this bond/stock comparative series. However, a recent note from a client has prompted us to undertake an additional study comparing common stock cash flow yields with bond yields.

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In this “In Focus” feature, 103 years of common stock dividend yields are compared. Today’s prevailing yields are put in historic perspective. Then various future stock market models are constructed, employing a variety of future earnings and dividend growth rates. Considering dividend yield history, the “super bulls” target of DJIA 3000 before the end of the decade seems close to impossible.

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