It may be difficult to find true “undecideds” in the political arena at this point, but with 10 weeks left in a challenging but consensus-defying year, there are some lively debates in the markets. There are many changes in position. For investors. Is the month-long rally in U.S. Treasuries a confirmation, refutation, or threat to the prevailing outlook for a soft economic landing? Are markets’ attempts to pre-empt the likely outcome of the US election a reliable signal of how policy is likely to affect the economy? And how should investors think about future stock returns as the bull market enters its third year riding a multi-year stellar performance and faces tough valuations? What are bonds saying? Is it? The rise in the 10-year Treasury yield from 3.6% when the Federal Reserve cut short-term interest rates by half a percentage point on September 19th to more than 4.2% last week is an unpleasant surprise that finally caught the attention of stock investors. It became a movement. US10Y 6M Mountain US 10 Year Treasury Bond, 6 Months This conveys a multifaceted message. It turns out that traders are betting on the Fed’s continued aggressive dovish stance, possibly further weakening the economy. Instead, economic data quickly took a surprising turn for the better as market-based inflation measures rebounded from multi-year lows, forcing the city to quickly lower expectations for future interest rate cuts. One way to look at it is that the bond sell-off was a panic attack, with 50 basis points of easing aimed at a resilient economy where stock prices are at record levels and credit spreads are near generationally tight. This is an indictment of the Federal Reserve’s policy mistakes. (One basis point is equal to 0.01%.) Or the bond market simply believes that the Fed’s commitment to lower interest rates toward neutrality while preventing unwarranted further weakening of the labor market will protect the economy from a harmful recession. Have you concluded that? It’s probably no coincidence that the 10-year Treasury yield has risen above 4%, only to return to where it was at the end of July, just before weak pay levels sparked two months of “growth anxiety” in the United States. Some economists said the Fed made a mistake by waiting too long to ease. This is a history of primitive soft landings the Fed has achieved in recent decades, when the 10-year Treasury yield rose more than 0.5 percentage points the following month immediately after its first rate cut in July 1995, and then resumed rate cuts. will follow. Decent in the long run. And, on a more abstract level, a 4.2% 10-year Treasury yield corresponds to a US economy currently operating at a nominal GDP growth pace of 5.5% (based on current GDP tracking models and the prevailing headline inflation rate). It’s not that they don’t match. Warren Paiz, founder of ThreeFourteen Research, said he sees the change in yields primarily as a result of macro improvements, and that 4.2% for 10-year bonds is, in fact, the “lower bound for fair value.” It’s also a technical level where if this were simply a counter-trend bond sell-off, there would be buyers for Treasuries. Estimates of what yield levels, both nominal and real, would put more pressure on stock prices tend to be slightly above current levels. Trading the Election Noise Bond price fluctuations are a global phenomenon, and because people often have differing opinions, they, along with just about everything else, are caught up in the inevitable election debate. Even though investment commentators and market historians have consistently warned that presidential elections are rarely significant movers in business cycles or the broader trajectory of a bull market, investors collectively There is little resistance to sticking to the policy and trying to get ahead of the economy. Policy implications. Over time, most of what the market wants from a presidential election is for it to be over, after which stocks tend to do well regardless of the dominant party. Yes, take advantage of lower taxes, lower regulations and higher trade barriers as betting odds tilt sharply towards Trump even though the polling averages are still too close to call with confidence A standard “Trump trade” constructed to do has come to light in recent weeks. Bank and cyclical leadership with a stronger dollar and higher bond yields are all consistent with this potential outcome, at least based on what is presumed to be a “repeat of 2016.” But isn’t this what we would expect to happen if the Fed eases, the economy improves, and corporate profits beat expectations at an above-average pace, reflecting the reality observed today? Ned Pat Chosik, senior portfolio manager at Davis Research, said that while recent market movements are correlated with the betting market odds of a Donald Trump victory, they are “positively tied to market drivers such as election sentiment.” It’s hard to differentiate between macro surprises… Trump speculators, on the other hand, are betting on the Fed’s larger-than-expected 50 basis point interest rate cut, September payrolls nearly 100,000 above consensus, and more. These are unlikely to be the main factors given all the positive developments since the beginning of the month, with sales surprising (on the upside) and the economic surprise turning broadly positive.” While the rally has several characteristics that indicate hopes for a Trump victory, history shows that when the Dow Jones Industrial Average rises from mid-August to Election Day, the incumbent party almost always gains. How do we explain the fact that it exists? The Leuthold Group says it has won. A more interesting question is whether the old Trump trade strategy will be just as useful if President Trump wins, given that the current situation is very different from before Trump’s victory in 2016. First, markets weren’t expecting Trump to win all that much in 2016, and there was actually a reflex sell-off on election night that quickly reversed. Markets quickly recognized the following policy mix as a formula for higher nominal growth rates in an expanding but underperforming economy due to chronically low inflation and stop-start growth. did. However, today’s setup is more like the opposite. In 2016, CPI inflation was consistently below the Fed’s 2% target. Today, the Fed has spent two and a half years trying to get inflation back toward 2%. In other words, expansionary policies that would speed up the economy’s metabolism and bring about more inflation were what the market desperately needed then, but what about now? In terms of position in the stock index field, the S&P 500 in late October 2016 was 18 months ahead of the start of the nasty 2015-2016 crash (China’s currency devaluation, industrial recession, Brexit). It was trading at levels previously reached for the first time. , the Fed is trying to raise interest rates in a so-so economy). Its forward price-to-earnings ratio was less than 17 times. The S&P 500 is now 42% higher than it was 18 months ago, trading at 22 times forward earnings. Taken together, this explains why there is still a push to protect in the short term from index volatility, and why companies like Wells Fargo say the election could become a sales event regardless of the outcome. This helps explain why. While it is plausible to the extent that Trump’s victory could be considered “risk-on”, it is somewhat of a frontier, and Harris’ victory is likely a result of the status quo/stalemate. What’s in the price? In any case, the trends and relative volatility of the market itself are still quite puzzling, with the S&P 500 briefly rising before returning to near all-time highs. Most stocks have been slowly digesting their recent gains over the past week, while teetering toward September closing levels. . There is no reliable evidence that a bear market is coming. The S&P is up 10 of 11 months, hitting a new high in September, and credit spreads are resolutely tightening, all of which point to an upward bias for at least several months. With cyclical leadership and future earnings forecasts at record highs, the Fed is moving toward an easing path that appears to be a priority: a solid economy without rushing. .SPX YTD Mountain S&P 500 Year to Date This leaves the question of how much upside should bulls expect from here? In the context of post-election easing of tensions toward the end of the year, consensus sentiment is rather overwhelming, but it is difficult to be completely contrarian in the face of the history of encouraging such movements. Goldman Sachs drew widespread attention last week when it released a new forecast that the S&P 500’s annual total return over the next 10 years will average less than 3%, worse than 96% of the past 10 years. Here, we derive our calculations from a starting point of 22x forward price/earnings and an initial dividend yield of just 1.3%. It also illustrates Goldman’s view that the index’s extreme concentration in a handful of the world’s best growth stocks is debt. As capitalism functions over time, the mean-reverting nature of corporate control weakens. The company painted various scenarios in which the annualized return reached 7% in a bullish case, which is perfectly respectable considering the annualized return of 16% over the past five years. It will be. Others on Wall Street criticized Goldman’s call as misguided and lackluster, but that in itself may be an interesting sentiment that suggests investors don’t believe a bumper crop will be followed by a bumper crop. do not have. I believe that low expectations are a secret weapon for investors who stay engaged, perhaps encouraging more discipline and higher investment contributions suited to a world where the market itself is less forgiving, while also being pleasantly surprised when things turn around. There is a tendency to think that it will bring about It comes out better.