As of mid-week, the stock market was cruising along, with the S&P 500 poised to top its September 20th all-time high of 2930.
Then along came bonds—and Federal Reserve chairman Jerome “Jay” Powell.
At the Atlantic Forum, Powell told interviewer Judy Woodruff of the PBS News Hour, “The really extraordinarily accommodative low interest rates that we needed when the economy was quite weak, we don’t need those anymore…We need interest rates to be gradually, very gradually moving back towards normal.”
This was really nothing new—Powell and his predecessor Janet Yellen had said the same thing many times. But immediately, bond traders went into a selling frenzy, and the yield on the ten-year Treasury note, which had hovered above the magic 3% threshold, soared: As of Friday, the ten year yielded near 3.25%, its highest since June 2011. (Yields move in the opposite direction of bond prices.)
The Dow Jones Industrial Average plummeted 200 points Thursday and closed down another 180 points Friday. The S&P was off by almost 50 points, and the Nasdaq Composite index had plunged over 250 points in the week’s trading.
Is this a real danger for stocks?
At this point, I don’t think so, but over the longer run, it might be.
We’re nearly ten years into an economic recovery. September’s jobs report had disappointing employment growth of 134,000, probably because of the impact of Hurricane Florence on the Carolinas, but July and August’s job growth was revised upward by a lot. Also, the unemployment rate fell to 3.7%, the lowest since 1969, when Midnight Cowboy and Easy Rider were on the silver screen.
This is extraordinary, leading Powell to tell Woodruff: “There’s really no reason to think that this cycle can’t continue for quite some time, effectively indefinitely.” Um…really?
All business cycles end, and not just because of policy “mistakes”; over time, excesses and leverage build up, people get complacent, and then markets overreact.
I don’t see that happening just yet. The economy is very strong, third-quarter earnings growth should exceed 20%, and as Chairman Powell indicated, inflation is under control. (Wages grew by only 2.8% year over year in September.)
But the big move in bonds suggests investors think economic growth is getting stronger and that inflation may begin to pick up, too. The question now is, will bond yields get so high investors will find them more attractive than stocks?
At 3.25% I don’t think so, but if they ever get to 4.5-5% again, they might be. That’s a long, long way from here, which is why after the current sell-off I expect stocks to rally again.