On Thursday the broad market indexes hit the support levels we had posted on Tuesday. From there they bounced and pushed back above the previous support levels broken on Wednesday. The buyers once again were willing to step in and buy base on what was perceived as an opportunity. I am not going to endorse that thought as valid, but it is what took place plain and simple. What took place in the equity markets was understandable and based on technical analysis and almost predictable. The major concern for me came relative to the bond market. Not just in Treasury bonds, but in investment grade corporates, municipal bonds, convertible bonds and junk bonds.
Looking at the chart below of TLT, iShares 20+ Year Treasury Bond ETF you can see the downside pressure on the price of the bond since the high on May 1st. This corresponds to the talk from the Fed of ‘tappering’ (I love all the new words we have this year for pricing events) or reducing the amount of bonds purchased by the Fed. The spike higher in yields has been a direct result of two events. First, fear and second, artificially low rates. The fear factor comes from the change element related to the Fed not being involved directly in the purchase of bonds. The artificially low rates comes from the involvement of the Fed purchasing bonds to keep yields low. The Fed is willing to purchase bonds for essentially a zero percent return, but the investor or bond buyers are not willing to accept those yield rates. Thus, the anticipation of not having the Fed directly involved is allowing the yields to seek levels that will attract buyers of these bonds other than the Fed. The big question mark hanging over bonds at this point… What is the magic number for the yield that will bring investor money into the bonds?
Corporate bonds (LQD) down 4.3% since the May 1st moved lower. Municipal bonds (MUB) down 3.3%, Convertible bonds (CWB) down 3.6%, High Yield bonds (HYG) down 4.1%, 30 year Treasury bond (TLT) down 7.1% and 10 year Treasury bond (IEF) down 3.6%. The damage has been big for such a short period of time on each bond sector.
The yield on LQD is 3.8%, MUB 2.8%, CWB 3.8%, TLT 2.7%, IEF 1.7% and HYG 6.5%. The question of where will these yields have to go to attract private investor money versus the Federal Reserves funny money, is the one question that demands a worthy answer. It is also the cause of the current volatility. The one thing we know for sure is 3.8% is not enough near term. The higher these yields climb the more impact it will have on the spending habits in the US. The housing sector could be impacted over time if rates climb too much. Another area of concern for investors.
All of this noise around the bond sector is having an impact on stocks as well. A look at the chart of the S&P 500 index shows the last two weeks have increased in volatility relative to concerns over the Fed’s ‘tappering’ rumors and discussions. The drop of 3.6% during this period is a vote of worry and concern about the interest rate and inflation impact on stocks. This isn’t likely to stop until there is some clarity about how high rates will have to climb for money to buy bonds versus the Fed. The more interesting question is what it will do the Federal budget as interest payments rise relative to the new interest rates on the bonds being issued to meet the deficit spending by Washington? Will the credit rating on the US Treasury bond get cut again? What will mortgage rates rise to? As you see the questions keep going and going. Is there any wonder the recent volatility in stocks may be here to stay for the foreseeable future?