We believe Treasury yields have made multi-decade lows that mark the end of the 30-year bull market for bonds. We further believe that, following the current correction, stocks will recover, with US stocks likely to make new highs before year end. The rise in yields has come as inflation expectations have fallen and growth expectations (real rates) have risen. In other words, the rise in yields reflects better prospects for economic growth, enough for the Federal Reserve to begin contemplating normalising monetary policy. The transition from a period of easy monetary policy to a more neutral policy can produce volatility, and it has often market the beginning of a sustained rise in longer term bond yields. Bear markets in stocks are typically associated with central bank tightening and recessions, not economies that are growing sufficiently to allow central banks to remove some stimulus. Thus we see the decline in stocks as a correction in a bull market.
David Fuller's view Fullermoney is similarly of the view that bond yields have bottomed. Additionally, we also maintain that stocks, although often volatile, are a better investment over the medium to longer-term environment that we have often discussed.
I think the paragraph from RiverFront above is a best case scenario. It could happen, for the reasons mentioned, but I have always expected a more turbulent period as the eventual ending of the USA's quantitative easing (QE) was discounted. By turbulence, I am mainly referring to at least several months of choppy ranging by stock markets. We have already seen some of that, but Wall Street has only experienced a modest reaction following its big rally which began last November. I would not be surprised to see the S&P 500 Index temporarily break its 200-day MA, in a manner similar to the expiration of QE in 2010 and 2011, as I also mentioned yesterday.
Also, there are downside risks to the global economy. China's attempt to regain control over its credit markets makes sense for the longer term, but it is also likely to cause somewhat slower GDP growth for at least the remainder this year. China is buying fewer resources and deflationary pressures have increased in many countries. The eventual ending of QE is a big, unfamiliar event and will lead to some additional uncertainty. We have seen some deleveraging in recent months.
I do not think that we need to be alarmed at these prospects but it may be prudent to reduce any extensively leveraged positions. In stock markets and possibly commodities, we are probably in a buy-low-sell-high trading environment.
If there is an historic Wall Street parallel in terms of approximate market action and where we are today, my guess is that it is somewhere in the late 1970s, as shown on these charts of the DJIA and S&P. However, the background fundamentals are obviously very different.