The Weight Of The Evidence
Looking at the stock market in isolation last week, it appeared “risk-on” was back in a big way. However, a peek behind the bull/bear curtain, painted a very different picture. From The Wall Street Journal:
After Lehman Brothers fell over in September 2008, equities slumped, then rallied back to their previous levels within a week. Brexit isn’t Lehman, but the stock market is behaving similarly…In 2008, shareholders made an epic mistake: They assumed Lehman would be manageable. This time the assumption is that central banks will ride to the rescue and corral any problems. Investors expect global easy money, adding yet another central-bank prop to the stockade protecting shares from weak economic growth. The result is some unusual, and worrying, behavior in the bond market. Since the Brexit vote, Treasury yields have tumbled, and they kept falling even as shares recovered.
Two Charts That Say A Lot About Confidence
During the financial crisis, demand for defensive Treasuries soared as economic and systemic concerns started to pile up. How have bonds performed relative to stocks since the Federal Reserve did an about face on interest rates in early 2016? The answer can be found in the two charts below.
Central Banks Vs. Slowing Global Growth
This week’s stock market video takes a deeper look into asset class behavior during the Brexit rally in stocks. How did the inflation trade hold up relative to defensive assets? Did European banks participate in the risk-on rally? Why did stocks rally? What could derail the rally?
Equity Leadership During The Brexit Rally
Not only did bonds outperform stocks last week, but leadership on the equity side of the ledger was decidedly defensive as well. From The Wall Street Journal:
Last week’s divergence of bonds and equities isn’t healthy. Bond markets are screaming that the world economy is slowing, and shareholders have their fingers in their ears singing “la-la-la I can’t hear you.” Stocks are no longer about growth, but about a desperate search for safe alternatives to low-yielding bonds. Since Brexit, the bond-driven nature of the stock market has been particularly stark. Four sectors in the S&P 500 are now higher than they were on the eve of the British vote, and none are a bet on the American economy’s underlying strengths. Utilities, consumer staples, health care and telecommunications sell stuff people need even in bad times; this is a defensive rally, not a dash for growth.
Inflation Trade Lags
Prior to the Brexit vote, we noted a concerning stall in inflation-friendly assets. The inflation-related trend continued during last week’s Brexit rally in stocks. From Bloomberg:
Inflation expectations derived from U.S. bonds are falling at precisely the same time that stocks have jumped, suggesting a “dangerous disconnect” between interest rates and equities, according to analysts at TD Securities Inc. “We believe that the equity market is complacent about the growth spillover from the uncertainty shock caused by Brexit, but is still pricing in monetary policy easing.”