The Bonds And The Stock Market

Crash or No Crash?

Sometimes you pull that rubber band so hard it stretches long and wide. When it snaps back, it hurts. People look at 1987’s crash and wonder if it could happen again. Whole books have been written that tie together various conspiracy theories to make a whole. There are just a few grains of truth to make it seem believable.

I have watched a few crashes and nothing was like 1987. 2001 the internet blew apart but the mainstays of the market and economy were okay. In 2008, the mortgage market melted down because the government backstopped it and rolled the dice. That allowed the big banks to build a house of cards that fell. In 2020, Covid induced a big drop in the market but that was regained almost as quickly. Today, much of the economy is in private markets and not public because there is ready and willing private capital along with the costs of being public which incentivizes companies to remain in private hands.

Can we have an ‘87 like crash again?

Never say never but there are actual structural things in place that stop it. Circuit breakers are one. There is better information flow than there was in 1987. Exchanges communicate amongst one another far better than they did in the past. The Federal Reserve is better at coordinating with banks and signaling than they were back then.

That doesn’t mean we can’t have an extended bear market. We can.

But, today, the rubber band seems to be stretching. The stock market is going up, and the ten-year note is also moving to higher and higher interest rates despite the fact the Fed cut at its last meeting.

There are other things that might be bullish or bearish. Inflation isn’t gone, but it has cooled a bit from its highs. Earnings for some companies stink, and for some seem good. We have a presidential election and my gut says if Kamala wins, stocks will take a short-term bath. Trump winning might see a break because you buy the rumor and sell the fact. A lot of the reaction to elections will be what happens in the Senate and in the House too. If Republicans sweep, Trump will be able to get some stuff done. If not, he is a true lame duck on Day 1. His only option will be to negotiate or do executive orders.

By the way, there is a lot of idle talk about fascism and Hitler these days. I noticed that Trump did a staged campaign event at a McDonald’s. It went viral and Trump looked great. Senator Big Chief Warren dashed off a letter and tweeted about McDonald’s accusing them of reaping big corporate profits by gouging customers on prices. The action by Warren is fascism in action if you don’t truly understand it.

Back in 1987, we all watched 30-year bonds. The long bond was where it was at. Even when I was trading short-term interest rates, we kept one eye closely on the 30-year at all times. In the mid-1990s, Alan Greenspan moved the duration of American debt from the 30-year bond to the 10-year note. It was thought that they could be “more precise” and have less variability.

When the country had 0% interest policies for so long, I thought the Fed made a mistake. They could have issued 50-year, or even 100-year bonds at low rates. They could have issued more 30-year bonds for sure. That action would have meant lower interest rate payments today. The US is probably the only country in the world that could issue very long-dated government debt securities at a relatively low interest rate cost.

Greenspan probably also assumed that government spending wouldn’t get out of control and it is most certainly way out of control today. I think Greenspan made a mistake in shortening the duration of the US government debt portfolio.

Neither candidate is talking about cutting spending and neither political party is talking about it either. But, it has to be done. If it isn’t done, we will eventually become a very sclerotic, top-heavy, centralized country no matter what anyone says.

Stock market action seems sort of rosy right now but when markets and participants get complacent, things happen. I’d keep a sharp eye on the ten-year note. If it continues to progress up to 4.5%, the stock market cannot stay bullish.

That snap you hear will be the rubber band whacking your portfolio.