W.AR! Famine! Death! AIDS! That’s how Bill Hicks, a respected comedian who died in 1994 at the age of 32, was shaken by the confusing effects of watching the news. Homelessness! Recession! Depression! Shocking headlines come to you relentlessly. But looking out the window, everything seems calm. The only sound is the chirping of cricket. You start to wonder, Hicks says: Where are all these bad things happening?
A lot of bad things are happening right now, especially a war in Europe. There are also fears of inflation and recession. Government bonds had their worst quarter for returns in ages. Treasury yield-curve reversed: The gap between yields on ten- and two-year bonds has recently turned negative, an early warning of a recession. The Federal Reserve is increasingly hockey. Yet the stock is surprisingly buoyant. A few days later this week in fairly deep red ink, d S.AndP The stock’s 500 index is just 7% below its all-time high. It may look like a stupid stockmarket that has failed to take its signal from the more realistic bond market. But the truth is more complicated.
There are many reasonable explanations for the resilience of stocks. An evergreen is that there is no better option for their ownership. Investors need to invest, and American stocks are the worst option. Bonding is a trap. As long as inflation is expected to surpass interest rates, they are a sure way to lose purchasing power. Yields on ten-year inflation-protected bonds are still negative despite large pricing in the bond market. The yield on equities is comfortably higher than the yield on these original bonds. And the stock provides some protection against inflation as much as corporate revenue is indicated by rising consumer prices.
However, the threat of recession in America is not immediate. The Fed has just begun tightening monetary policy. Even a rapid series of interest rate hikes will take time to slow down the economy. The negative spread between the ten- and two-year yields is an early-warning signal, not a disturbing alarm. On average, this part of the yield curve hit the recession more than a year after the reversal. Meanwhile, the equity market usually goes up. Seen in this light, the message of holding stock for the time being should be taken.
Underlying all of this rationale is the notion that equity investors do not fully believe that the Fed will adhere to all interest rates pricing the bond market. The public.) A strain on this belief credits the Fed too much: it says it can easily beat inflation without upsetting the economy. Another strain gives it very little credit: this school suspects a recessionary engineer Fed’s stomach for price stability. If this kind of frustration results in inflation staying above the Fed’s 2% target for a long time, then so be it. This will be a bigger problem for bond returns than equity.
It is possible to pick holes in all these arguments. But it is not right to conclude that the stock market has failed to adapt to the new and harsh realities. In the best performance industry S.AndP The first quarter had 500 who could be resilient to sustainability: power, utility and consumer main. Meanwhile, technology stocks – the flagship of an era of “secular stagnation” of low inflation and low interest rates – have spent months ruthlessly. The turbulent violence of this sector away from technology has created some ripples in the overall stock market significantly. Yet, equity investors were aware of the world outside their window. Bank of America Global Fund-Manager survey suggests investors have weighed technology stocks in their portfolios before November, Kevin Russell notes UBS O’Connor, the hedge-fund unit of the Swiss asset manager. The stock market is ahead of the bond market in the risk of inflation, not behind it, he argues.
The big question is how far all financial markets are running behind the reality of inflation. At a stage where asset prices are in line with the possibility of a tight Fed policy, the course does not seem to have been fully run. And the pattern of the last two years is to quickly shift from one market stage to another. Nowadays everything is moving fast. But the relentlessness of scary financial headlines is not a combination of 24-hour news cycles. Instead it is a reflection of a super-charged business cycle, which looks a lot like Bill Hicks-set to shine bright and die young.
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This article is published in the Finance and Economics section of the print edition under the title “Double-Glazed”