By Sue Chang, MarketWatch
Appetite for stocks tends to taper when 10-year Treasury yield
moves above 3%
Albert Edwards, global strategist at Société Générale, this week
cautioned that the moment of reckoning for stocks is near and
investors should stop buying into the fantasy of a robust economy
as a recession is lurking right around the corner.
The stock market, he said, "truly has drunk the strong economy
Kool-Aid (https://www.youtube.com/watch?v=nJPoKTQT2i8)."
That warning comes as the Federal Reserve is all but certain to
raise the benchmark interest rate when the Federal Open Market
Committee meets next week. And as the central bank maintains a
hawkish stance, investors are wondering how high Treasury yields
can go before the stock market's red hot rally hits a wall.
Conventional wisdom suggests that once the 10-year note starts
yielding more than 3%, appetite for stocks tends to taper.
But for Edwards, the market is already on precarious footing and
it has only mere months to go before everything falls apart.
The strategist -- who has doggedly warned that the central
banks' easy-money policies since the 2008 financial crisis have
created a giant bubble that would eventually plunge the global
markets into a financial ice age -- believes 2018 is looking a lot
like 2007.
"The economic data looked just as strong back in June 2007 and
only a few mavericks had figured out a recession was on the way,"
Edwards told MarketWatch.
If history repeats itself, which he seems to think it will, the
selloff in stocks will be triggered by rising yields on the back of
improving economic data even as expectations for inflation remains
muted.
"Then, like now, enthusiasm on U.S. growth was reaching its
heady climax," he wrote in a note to clients.
And although the famed perma-bear himself declined to predict a
specific number that could trigger a market collapse, he cited
research from his colleague Stephanie Aymes who projected selling
pressure to accelerate when the 10-year Treasury yield nears 3.05%,
a level that was recently breached.
"The Citi Economic Surprise Index for the U.S. had slumped back
towards zero. That convergence of expectations with the data
normally means yields should have continued to paddle sideways
around 2.8% -- and yet we have seen this dramatic rise," he
said.
The yield on the 10-year note moved above the closely watched 3%
mark on Monday with upward pressure expected to steadily build as
the Fed continues to tighten the monetary policy on a booming
economy. The central bank is widely expected to hike the
federal-funds rate, currently at 1.75% to 2%, by 25 basis points
when the FOMC convenes its two-day meeting on Sept. 25.
Edwards's bearish outlook rings hollow at a time when the U.S.
economy is prospering and corporate earnings are growing by double
digits. Yet, his references to a looming recession may not be as
outlandish as it seems given concerns about an inverted yield curve
where long-term yields such as the 10-year Treasury yield fall
below their shorter-term peers. This inversion typically happens
when confidence in the economy is weak and is viewed as a harbinger
of doom as it has preceded every U.S. recession over the past six
decades.
A number of strategists expect the 10-year/2-year yield curve to
flip some time next year with Oliver Jones, a markets economist at
Capital Economic, projecting an inversion in early 2019.
The 10-year yield traded at 3.06% and the 2-year hit 2.80%
Friday, a mere spread of 26 basis points.
In contrast to Edwards, Tom Lee, managing partner at Fundstrat
Global Advisor, said stocks should remain largely immune to the
adverse impact of higher rates until the 10-year tests 4% which is
where price to earnings ratio starts to feel pressure.
"A sustained rise in rates has the biggest effect on growth
versus value [stocks], favoring value," he said.
Meanwhile, most fund managers surveyed by Bank of America
Merrill Lynch said that 3.6% is the "magic number" that would make
them rotate away from stocks into bonds.
The central bank has telegraphed four interest-rate hikes this
year or one each quarter, with the markets penciling in another
increase in December after this month.
However, mounting friction between the U.S. and China could
result in a more cautious message from the central bank, according
to Bricklin Dwyer, U.S. senior economist at BNP Paribas.
"We expect a discussion of the 'downside risks' to growth and
'upside risks' to inflation posed by these trade policy changes in
both Chair Powell's press conference and the subsequent minutes of
the meeting," said Dwyer in a note.
President Donald Trump on Monday announced new tariffs on about
$200 billion in Chinese goods and threatened additional penalties
as part of his effort to force trading partners to offer more
advantageous terms.
In response, China retaliated with tariffs of 5% to 10% on $60
billion worth of U.S. products that will take effect Sept. 24 and
said it may introduce more measures if the U.S. goes ahead with
higher tariffs.
Stocks, however, mostly shrugged off heightened tensions with
the S&P 500 index up 0.9% and the Dow Jones Industrial Average
rallying 2.3% for the week. The Nasdaq bucked the trend for a
weekly loss of 0.3%.
(END) Dow Jones Newswires
September 22, 2018 17:14 ET (21:14 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.