Sans the ever wilder world of bitcoin – more of the same since last
month’s note, as spreads between short and long-term Treasuries continue to
narrow, with 2’s and 10’s earlier last week at their tightest levels since the
previous equity market peak in October 2007.
That said – and contrary to the market environment in Q4 2007 where
spreads had been widening for several months as both short and long-term
Treasury yields fell, but shorter-term yields fell faster – the curve today has
continued to flatten as shorter-term yields have climbed and “outperformed” the
long-end, greatly buoyed by staunch confidence of another rate hike by the Fed
this week and tepid expectations towards rising inflationary pressures next
year.
The cyclical disinflationary gravy train that began in Q4 2011 as the US
dollar and real yields carved out their respective cyclical lows, has handsomely
rewarded both equity and credit investors alike, at the expense of more
inflationary driven assets – like commodities. And while there are many that
believe that a secular move higher in equities began in 2013 as indexes broke
out above their previous 2007 cycle highs, that observation appears mostly biased
by simple technical disposition and ignorant of a wider historical perspective
and understanding of the long-term yield/growth cycle – we believe essential to
even considering more lasting secular persuasions.
The long and short of things – which appears entirely personified in the
speculative microcosm of bitcoin mania these days: trade it while it lasts, but
don’t be fooled by price alone. Valuations anchor all returns in the long run,
and that rope between expectations and reality is exceptionally long and extraordinarily
taut today.
Besides the unconventional and extraordinary monetary policy approaches
applied in the markets since the global financial crisis, expectations continue
to be muddled by the massive scale of the long-term yield and growth supercycle
that we believe ultimately exerts the greatest influence on the respective equity
and commodity sub-cycles over the long-term. Simply put, investors need to
balance expectations by also viewing the overarching cycle through a market
historian’s wide-angle lens, rather than just a weatherman’s radar display of
current market conditions.
Granted, much easier said than done, as prudence typically takes a back
seat to the ever pressing consequence of the fear of missing out. Heck, what’s
a measly 20 percent return, when your kid’s teacher bought some crypto last
week and doubled his “investment” – just because his nephew bought a bitcoin
financed Bimmer on a cheap ticket punched in June? As if Millennials weren’t disliked
enough already, returns in their preferred investment vehicle over the past
year rival equities over the entirety of the more than 35+ year secular bull
market. From a speculative point of view, there’s never been anything like it –
and it’s happening right now. Chew on that.
Getting back to a
more stodgy and puritan landscape… When you look back at the span of the broader long-term
yield cycle, you'll find it was a period in history that encompasses 70+ years
of remarkable growth, the last 35+ of which were traveled with increasingly
benevolent credit conditions, in which the US has enjoyed elevated equity
market valuations on the back of a proportionately massive secular downdraft in
yields. Historically speaking, the significant investments and
advancements in the world economy that took place directly after World War II,
helped drive growth, inflation and eventually yields to such Icarus heights –
that countries, central banks, corporations and individuals have enjoyed the
voluminous book-end benefits of a declining rate environment for well over 35
years. This in a nutshell built the long road to the top of the equity market
cycle on the back of ever cheapening credit and ever more accommodative
monetary policy.
Interestingly, the
relative symmetry represented in the current yield cycle is not unusual and
quite characteristic when you look back at several hundred years of market history.
* Click to enlarge images
The previous cycle (from trough to trough) spanned 40 years to the month; a
period in which yields rose for 20 years – followed by a 20 year
decline. Unlike the current downtrend in yields that has trended to the
trough with increasingly more symmetry with the mirrored rise in yields from
1941 to 1981, the previous cycle exhibited an asymmetric return below the 1901
lows, as economies pushed up against the limits and unbalances exposed and
magnified during the great depression - and markets stumbled their way across
the transitional divide to the next major growth cycle.
Comparatively, the
secular peak in yields in 1981 was over three times as steep as the previous
secular peak in 1921 – and the broader span from trough to trough of the
current move (1941 - today) will likely be over twice the previous cycles
length (1901-1941'). Consequently, the massive range and structure of the
current long-term yield/growth cycle represents the enormous scale that market
participants should balance their more long-term and secular expectations
within.
Believing that the broader system will normalize and reboot to the next
long-term cycle without a prolonged period of transition (i.e. secular
stagnation - we like transitional divide) – even proportional and commensurate
with the previous trough – is unfounded even along the irrational continuum markets
often walk out on. In this respect – and as was the case across the
previous transitional divide in the 1930’s and 1940’s, look for alternating periods
of outperformance between equities and commodities extending well into the next
decade, before a more secular move higher begins beneath growth, yields and
equities.
The main takeaway for
us, is that although equity markets have extended far offshore to relative
valuation extremes today, the anchor of the broader long-term yield and growth
supercycle will eventually pull returns lower as economies move further away
from the easy credit conditions and accommodative monetary policy approaches
that have greatly defined the current disinflationary sub-cycle since 2011.
Considering the major influences of US dollar strength and extraordinary
monetary policy accommodations that have gradually receded over the past few
years, the disinflationary tradewinds that have greatly supported equities –
but were headwinds for commodities, will eventually dissipate entirely in the
current doldrums (i.e. goldilocks conditions) the markets remain in. Filling
the void will be either rising inflation – deflation, or relatively brief cycles of both. We suspect we’ll
see the former stretch its legs further, before the latter threatens yet another
return. That said, we’re reminded this isn’t the summit of the yield/growth
cycle of the 1970’s were inflation had ample fuel to burn – but likely the middle
of the trough, where outbreaks of inflation burn fast and bright before
exhausting whatever oxygen remains in the economy.
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With November’s CPI
report coinciding for release with the December Fed meeting announcement
Wednesday afternoon, markets will be provided ample catalyst and reaction to
trade between. Gold, which has remained mostly under pressure since its late
summer high, has found major tradable lows shortly after the two previous
December rate hikes in 2015 and 2016. It traded out of a bear market cycle low
in December 2015 – directly after the Fed’s initial rate hike off ZIRP; and
successfully defended that low the following December as the Fed hiked once
more. Should the CPI report come in hotter than expected, look for gold to test
underlying trend line support ~ 1215, before reversing course into the end of
the year.
Generally speaking,
gold has continued to trade higher – even as the Fed has raised rates four
times over the past two years, predominantly because real yields have continued
to fall as the dollar’s cyclical bull market turns down. In this regard, the
dollar’s year-over-year performance trend has continued to decline this month,
which would indicate that real yields should follow suit, largely supporting
the cyclical uptrend in gold that began two years ago.
Overall, we continue
to watch the slow battleship turn in the US dollar, with the fundamental belief
that similar to the trend in long-term yields, the dollar will also work its
way back down to the trough of its long-term range, coinciding with another
cyclical move higher for gold and commodities in general.
