Investment Commentary – April 26, 2022
Year to Date Market Indices as of April 26, 2022

• Dow 33,358 (-7.96%)
• S&P 4,194 (-11.67%)
• NASDAQ 12,563 (-19.35%)
• Gold $1,709 (-10.12%)
• OIL $61.65 (27.26%)
• Barclay Bond Aggregate (-9.86%)
• Fed Funds Rate 0.50

  1. Could bonds rally with inflation high and the Fed raising rates? More market-timers are betting on it.
  2. The bond market has absorbed an enormous amount of bad news. The tide may soon turn.
  3. Bond market pessimism has become so extreme that a rally is a distinct possibility.

Pessimism about bonds has been at extreme levels for several months now and the market has stubbornly refused to rally. What’s different now is the willingness of a few (though a growing number of) brave advisers to buck the consensus. Rather than falling over themselves proclaiming how awful bonds’ prospects are, more and more bond advisers are beginning to tiptoe in the direction of being less bearish — if not outright bullish.

In focusing on the potential power of this emerging narrative, I have in mind research from Yale University finance professor (and Nobel laureate) Robert Shiller. In his latest book, Narrative Economics, Shiller argues that the stories that we tell ourselves affect not only our individual behavior but our collective behavior as well. By paying attention to these narratives, we can improve our ability to forecast the markets.

The emerging bullish narrative about bonds has hardly gone viral — at least not yet. Most of the bond market headlines in the financial press still focus on how awful the year-to-date period has been for fixed-income investors. Nevertheless, in recent days I’ve noticed a distinct shift among the bond market advisers I monitor.

Their bullish arguments fall into four major categories:

Inflation: A growing number of advisers are now referring to “peak inflation.” Earlier this week, in fact, even Fed chairman Jerome Powell acknowledged that the Consumer Price Index’s trailing 12-month rate of change may have peaked with the U.S. Labor Department’s Apr. 12 report — at 8.5%. If inflation does decline, the Federal Reserve would feel less pressure to raise interest rates as aggressively as the market currently expects.

Economy: The odds of a recession have grown in recent weeks. One of many straws in the wind suggesting a recession is the inversion (or near-inversion) of the yield curve. Goldman Sachs now puts the odds of a recession at 35% within the next 24 months. If a recession were to occur, bonds almost certainly would rally.

Technical: When judged according to past rate-hike cycles, interest rates may have already risen enough, according to Joe Kalish, chief global macro strategist at Ned Davis Research. Since March 16, when the Fed began the current rate-tightening cycle, the 10-year Treasury yield TMUBMUSD10Y, 2.754% has risen 75 basis points, or 0.75%. That exceeds the median increase of 61 basis points during the entirety of previous Fed tightening cycles, according to Kalish’s calculations. Technical analysts Mary Anne and Pamela Aden reach the same conclusion through their analysis of interest rates’ long-term trends. They predict that “long-term interest rates are unlikely to rise much further and they’ll soon turn down.”

Sentiment: Though bond-market timers have been incredibly pessimistic for several months now, it’s important to acknowledge their pessimism since it means that when the bond market turns up, the rally will be resting on a solid sentiment foundation. The chart below plots the average recommended bond-market exposure level among a subset of several dozen bond market timers my firm monitors (as measured by the Hulbert Bond Newsletter Sentiment Index, or HBNSI). Notice that the HBNSI has been low for some time now. For a couple of months straight it has remained in, or close to, the bottom decile of the historical distribution—the range that in previous columns I have used to identify excessive bearishness.

The bottom line? The bond market has absorbed an enormous amount of bad news. The tide may soon turn.


Around the Web

Half-point hike? It’s looking increasingly likely that the U.S. Federal Reserve will accelerate the pace of its interest-rate increases, based on public comments Thursday from Jerome Powell. The Fed chair said the central bank is likely to raise its benchmark rate by a half percentage point at its meeting on May 4. It’s more typical for the Fed to raise rates by a quarter point at a time, as it did in its March meeting.

Q1 GDP ahead: A report scheduled to be released on Thursday will show whether the U.S. economy’s strong late 2021 momentum carried over into early 2022. The government will release its initial estimate of first-quarter GDP growth. In the previous quarter, the economy expanded at an annual rate of 6.9%; for full-year 2021, the rate was 5.7% on an inflation-adjusted basis—the fastest growth since 1984.

Earnings surprises: With the earnings season now about 20% completed, the proportion of S&P 500 companies that had beaten analysts’ net income expectations stood at 79% as of Friday, according to FactSet. That so-called beat rate ranks slightly above the 77% five-year average. Across sectors, energy and materials stocks are expected to report the strongest earnings growth overall.

Upcoming Events
Thursday: First-quarter GDP, advance estimate, U.S. Bureau of Economic Analysis

Today in Stock Market History:

2000: The NASDAQ has one of its worst days ever, plunging s 355.49 points, or 9.67%, to finish at 3321.29, down 25.3% for the week. But “tech stocks have largely gone through their valuation adjustment,” says Lehman Bros. strategist Jeffrey Applegate, who urges investors to buy. Robert Froelich, chief executive of the Kemper Funds, scoffs that the drop is “the bear’s brief day in the sun” and adds, “this is the greatest opportunity for individual investors in a long time.” Thomas Galvin, strategist at Donaldson, Lufkin & Jenrette, pronounces that “there’s only 200 or 300 points of downside for the NASDAQ and 2000 on the upside.” It turns out there are no points on the upside and more than 2000 on the downside, as the NASDAQ ends the year at 2470.52, on the way to its trough of 1114.11 in October 2002.

The views presented are not intended to be relied on as a forecast, research or investment advice and are the opinions of the sources cited and are subject to change based on subsequent developments. They are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investments. (Market Indices) (Around the Web & Upcoming Events) (YTD Performance Chart)