Stock and Bond Market Update

While all the world focuses on the debris rising up in the tornadoes engulfing Hollywood and Washington (Roy Moore, Harvey Weinstein, Kevin Spacey, Trump and Russia, Hillary and Russia, etc.), the stock market continues to drift pleasantly higher.  How much longer can this continue?  What is the long term outlook for the stock and bond market?

The Stock Market

      The S&P 500 has been on quite a winning streak for the last two years.  On November 10th, it recorded the longest streak since 1928 without a 3 % correction.[1]

It is also one of the longest rallies on record without at least a 10% decline.[2]

So does that mean a major bear market is just over the horizon?  Though these uninterrupted streaks certainly call for caution in the short term, our Chief Investment Strategist Jeff Saut has argued for quite some time that we are in a long term secular bull market: “The stock market since 1900 shows that secular bull markets tend to last 14+ years. So, even if you want to measure from the 2009 nominal price lows (we are not so sure that’s the right starting point), we still should have years left in this Bull Run.”[3]

I concur with Jeff.

As I’ve mentioned a number of times in previous posts, there is always a great deal of noise regarding the outlook for the stock market and the economy.  Every day on CNBC you can find a chart or two that is supposedly pointing to a rise or fall in the market.  Most of these “leading indicators” only lead investors astray; their track record is usually very spotty.  I try to focus on indicators which have performed reliably in the past.  Below are 3 of my favorites.  None of them are behaving as if there is a recession on the immediate horizon.  (Shaded areas are previous recessions.)

The Bond Market

        I’m a long term stock-market bull, but the exact opposite regarding the bond market.   Interest rates have been in a steady decline since the early 1980’s, as you can see from the chart of the 30-Year Treasury Bond below. [4]  This means that bond prices have been in an almost uninterrupted rise during this entire period.  (When rates decline, long term bond prices rise.)  I believe that the bond bull market is over, and in all probability ended on 7/06/16 when the yield on the 10-Year Treasury Note touched 1.33%.  We look like we are in the early stages of a worldwide pickup in economic growth, which will lead to at least some increase in inflation and a subsequent rise in rates.

What does that mean if you’re a bond investor?  From July to December of last year the yield on the 10 Year Treasury Note rose from 1.33% to 2.61%.  You can see the effect on bond prices below.

During this period, the price of the 10-Year declined 7.5% and the price of the 30-Year sank a bear-market-qualifying 16%.  You can expect more of the same if rates continue to rise.

Does that mean that bond investors should sell all their bond holdings and jump into the stock market?  Absolutely not!  There are potential ways you can protect yourself.

First, shorten the maturities in your bond holdings.  If you own bond funds, look at the average duration of the bonds they own and make sure it is no more than 4 years.  When rates rise, short term bond prices decline much less than long-term prices.

Second, there are types of bonds whose prices typically fare better when rates rise.  These tend to be credit sensitive issues such as bank loans and high yield which benefit from improving business conditions as the economy picks up. [5]

Bottom line: be prepared for a short term correction in the stock market, but longer term, stay bullish.  Also, be prepared for the media to beat the doom and gloom drums once that correction occurs.   With regards to bonds, shorten those maturities!

 

 

[1] Raymond James Morning Tack 11/10/17 (here)

[2] Raymond James Morning Tack 11/10/17 (here)

[3] Raymond James Gleanings 7/25/17 (here)

[4] MacroTrends website, 11/14/17

[5] Blackrock

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