This afternoon, the US stockmarket slid so hard at the open that it triggered a circuit breaker. In effect, the market was given a “time out” so that it could gather its breath.
Having reopened, the S&P 500 did seem to regain a little bit of composure – it’s now only down about 5% as I write. But it's a big deal, no doubt about it.
And yet, believe it or not, there are even more momentous events occurring in what is traditionally viewed as one of the most boring markets on the planet – the government bond market. I will admit that we have been saying for a very long time that the valuations in the bond market appear to make very little sense. But the latest moves have surprised even us.
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A quick refresher. Bonds are IOUs, typically with a fixed annual interest payment (the coupon). So when bond prices go up, their yields go down (because the yield is the coupon as a percentage of the price – it’s a little more complicated than that, but this will do for our purposes).
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In the last two sessions, US government bonds have made history. Regardless of how long you lend money to the US government, you are now getting paid less than 1% a year.
Other bonds are even more ridiculous. Bonds in Japan, Germany, and much of the rest of the eurozone have been in negative territory for a long time (ie, investors are – technically speaking at least – paying governments to “look after” their money for them). But now even bonds in the UK (where central bank interest rates remain positive) have dipped into negative territory across many maturities.
Bond yields this low suggest that investors are so panicked that they’d rather face a guaranteed loss than risk putting their money anywhere else.
So what’s going on? As Louis Gave of Gavekal puts it, there are really only one of two options as to what to believe when faced with moves this extreme. Either this is a “blow-off top”, the charmingly-named technical term for the fit of mania before a bubble (or long-term bull market, depending on whether you were invested in it or not) finally pops.
Or it really is different this time. In that case, perhaps "the world is facing an economic ice age” (presumably a nod to the thesis of Albert Edwards at Societe Generale, who expects bond yields to go even more negative from here as deflation takes hold worldwide).
Gave is no Ice-Ager, but he acknowledges that there are a couple of big factors that could catalyse an ice age. One is the fall-out from the coronavirus itself. And the other is the all-out war that’s just been declared in the oil market.
The latter will hit investment spending in the US as troubled shale producers scrabble for all the cash they can lay their hands on. That is likely to damage US growth and could cause further jitters in the corporate credit markets.
However, argues Gave, the bond market moves may equally have been triggered by insurers and pension funds piling in due to the need to offset their future liabilities in the face of yet more declines in interest rates. That risks becoming a self-fulfilling feeding frenzy, exacerbated by the Federal Reserve’s panicky rate cut last week.
And as James Ferguson of MacroStrategy Partnership points out, stocks – certainly in the UK – are starting to look inexpensive compared to their valuations during previous recessions.
In short, there is likely to be more turbulence ahead. But is the market over-reacting? Arguably yes – particularly if you assume any sort of government action to “stimulate” the economy further.
