Rise in Bond Yields Raises Concerns

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Société Générale’s strategist, Albert Edwards, has compared the current surge in bond yields to being trapped in a car headed for a crash. In a recent note to clients, Edwards warns of a potential stock market event similar to the crash of 1987 if the bond market does not cool down.

While the S&P 500 had its worst month in September, experiencing a 19% plunge in 2022, it is still up by 11% for the year. However, the bond market chaos has led to the yield on the 30-year Treasury reaching its highest point in over a decade, placing renewed pressure on bond prices.

Drawing parallels to the events of 1987, Edwards states that the equity market’s resilience in the face of rising bond yields is reminiscent of the optimism seen prior to the crash in 1987. He highlights that any hint of recession now would deal a devastating blow to equities.

The chart below provides a glimpse into the events of 1987 when concerns over overvalued stocks, rising interest rates, and higher fiscal deficits culminated in the infamous Black Monday crash on October 19. On that day, the S&P 500 lost 30% of its value, resulting in global losses estimated at over $1.7 trillion.

Edwards’ alarm coincides with a warning from a J.P. Morgan Asset Management strategist who believes that the ongoing surge in yields could potentially trigger a “financial accident.”

Economic Uncertainty Persists

In the current economic climate, there is a notable lack of clarity regarding our position in the economic cycle. Analysts and investors are divided between the possibility of a long-awaited recession or the beginning of a new economic phase. One prominent voice in this discussion is Edwards, who expresses his belief that a recession is still on the horizon. However, he acknowledges that he, like many others, has been proven wrong thus far.

One indicator that supports Edwards’ view is the significant decline in trucking jobs, which historically has foreshadowed a recession. Moreover, he identifies other concerning signs that point towards an economic downturn. These include a surge in bankruptcies among smaller companies and signals from the money supply, such as the contraction of M2 (which measures U.S. cash in circulation, checking deposits, savings deposits under $100,000, and money-market mutual funds) and M4 (which measures notes and coins in circulation, along with bank accounts).

Interestingly, economists, particularly those at the Federal Reserve, have recently downplayed the significance of the money supply. However, Edwards disagrees with this perspective. While he wouldn’t classify himself as a staunch monetarist, he emphasizes the importance of monitoring money supply weakness and urges economists to take note when it is confirmed in the data.

Additionally, Edwards revisits his “maddest chart,” which illustrates the drastic decrease in corporate net interest payments. This trend deviates significantly from recent history and highlights how corporations have borrowed at low rates over extended periods from 2020 and 2021. Paradoxically, they then lend these funds back to the U.S. government at higher short-term rates.

Overall, the economic uncertainty remains pertinent, prompting cautious observation of these various indicators that paint a potentially worrisome picture.

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