Over the past three months, we have seen a massive divergence between the stock market and bond prices. Typically, these are highly correlated because money moves from bonds into stocks and vice versa.
However, over the recent three months, we have seen bonds move lower, causing yields to increase while, at the same time, money flowed into stocks, driving the price higher. Eventually, the yields on risk-free bonds become so attractive that the money has to flow back out of stocks and into bonds. We saw this occur dramatically in August '23.
Overvalued Stock Market
Several significant risks are threatening the stock market to drop even further. The market, as of 31 July, has a PE Ratio of 31.4, which is higher than the price before the Global Financial Crisis (23.4) and even higher than the pre-Dot Com bubble (30). So fair to say all the money injected into the economy during covid has been hiding out in the stock market for the last year or so.
Treasury issuance
According to US Treasury Securities Statistics, as of July '23, there has been a 23.8% year-over-year increase in the issuance which is reflected in the downward price pressure on bond markets this year.
Over the next few months, there will be an avalanche of new treasuries being issued. This is predicted to create further downward pressure on the prices of treasuries, and may even cause a supply glut (Bloomberg), pushing their returns up and making them even more attractive to funds currently invested in the stock market.
Raising rates everywhere
Because rates in countries worldwide have been rising, this creates additional competition for the US treasuries contributing to the oversupply of US treasuries.
Reduced Available cash
As costs have risen everywhere, people's savings have been reducing dramatically over the last 18 months. The excess savings rate in the US has dropped to a decade-low of 4.3%. We have not observed it this low since 2008, right before the market crash. This indicates there is not as much cash available to absorb the new issuance of Treasuries, reducing the relative demand further.
Our Stock Market prediction
Legendary investors like Michael Burry have taken out massive 'short' positions on both treasuries and the stock market. Betting up to 90% of his portfolio (CNN) that a market downturn is coming.
If an oversupply in Treasuries over the coming few months results in long-term rates rising substantially, then we can expect it to start sucking in money from everywhere and currently, the only place where there is lots of spare cash is a stock market that has ballooned 32% since the beginning of the year.
We don't know the exact time frame, so rather than predict times, we can look a the coming events in sequence as follows;
Short-term high rates
Stable or rising Fed funds rate
Further issuing of Treasuries to pay interest and fund increase governmental expenses.
Continuing decline in 20-year treasury futures pricing (increase in interest rate)
Continuing decline in the stock market as money flows into Bonds
Medium-term recession
After sustained high rates, the economy will begin to slow (may enter recession)
Inflation will nose-dive as the economy slows
FED will decrease rates to simulate
Long-term growth
FED decreases the federal funds rate
Treasuries' interest rates follow the decline making them less attractive investments.
Low stock valuations (after a sustained decline) create an attractive investment opportunity for funds instead of treasuries.
When the federal funds rate bottoms out, we predict the stock market will start a new bull run.
This information is intended for educational purposes only and is only opinions of market observations but does not constitute individual investment advice or recommendations. Before making any investing decisions, please do your own research or consult a financial advisor where necessary.