The parabolic peak in 2-year Treasury yields this winter ended in a crescendo on Thursday March 9 and Friday March 10. That week, the collapse of Silicon Valley Bank had completely spooked markets and convinced traders that the Federal Reserve would be forced to start reversing its bullish cycle and the hawkish rhetoric that accompanied it. By Sunday afternoon, March 12, the FDIC had stepped in and resolved the bank. It was finished. A few weeks later, First Citizens Bank announced a deal to acquire what remained of its branches, customer and employee deposits.
The bond market reacted quickly to these developments, with yields falling precipitously just before the bailout while several other banks capsized and a chill hit traders old enough to remember the 2008 financial crisis. increased as capital fled to safety. Interest rates on Treasury bills fell in line with the rise in prices. All of a sudden, inflation no longer seemed to be the biggest risk in the markets.
This weekend, I had declared that the top of the 2-year Treasuries had arrived. Not forever, but for a while. You can read the piece here.
It wasn’t a terribly brave call, given all the fear of what a systemic bank run could do to the economy. But whatever, it was fair.
Here’s what the 2-year Treasury rate has done since:
We were as low as 3.75 and haven’t seen 5% since. The overnight rate (or federal funds rate) is now five and a quarter. The 2-year no longer takes it to higher ground, despite recent strength in the labor market and a series of positive economic surprises. The early March peak still seems to be the top of the cycle.
More interesting – and the thing I didn’t see coming – has happened in the stock market since that 2-year bond high.
The Nasdaq has gone crazy.
In orange, the Triple Q ETF explodes 22%, taking off like a rocket at the start of the bond explosion (purple).
I wouldn’t give the bond market all the credit for the comeback of large-cap growth stocks since March. Several other things happened. First, as earnings rolled in for the first quarter in April, we relearned the difference between economic data and the resilience of Corporate America’s profit machine.
It turns out that US executives have plenty of levers to pull, despite demand slowdowns, cost pressures, and more. Six months of layoffs contributed to both earnings stability and sentiment-driven multiple expansion. The index-weighting giants have somehow heeded the earnings numbers, though they have been challenged by revenue growth. It was crucial. Analysts were expecting a 7% year-over-year drop in corporate earnings in the S&P 500 and by the time we got the last of the reports, that was looking more like minus 2.
Also, it is important to remember where we started from. Meta was down almost 80% from its peak. Amazon and Alphabet had been cut in half. Even Apple was down 30%. The Nasdaq as a whole had seen a 35% peak-to-trough selloff from November 2021 to October 2022 and they still hadn’t recovered much at the start of 2023. There was plenty of room upside and very little upside. enthusiasm for these stocks, so when they started to exceed expectations, the effect was like a powder keg bursting. Oh wait a minute, Microsoft is still pretty awesome. Yeah, no shit.
We also had a unique moment of technological awakening as the ChatGPT phenomenon began to capture the public imagination. Suddenly, CEOs started talking about the huge potential of AI and it fueled a hunt for every company that had substantial AI efforts – with large-cap tech being the epicenter of it all. Nvidia’s explosive earnings report, during which it doubled down on its forecast, served as an affirmation that the hype had a solid basis in reality. The company added $200 billion to its market capitalization in a single day, an unprecedented milestone in stock market history. AI was not just a theme, it was a clear business opportunity present here and now. The stock prices of hyperscalers – Alphabet, Amazon, Microsoft, Meta – have gone absolutely crazy. You had to own them.
By late May, Wall Street strategists had begun raising (yes, raising) their earnings outlook and year-end targets for the S&P 500. In early June, Wall Street economists followed suit, with bets updated GDP outlook and reduced recession probabilities to match stock market optimism.
We now find ourselves in a situation where the resilience of companies’ ability to increase their profits is fully demonstrated. At the same time, lower inflation is becoming apparent everywhere (inflation peaked at 9% last June and is rapidly heading towards a handful of 3s according to consensus expectations). April inflation, which was reported last month, fell for the tenth consecutive month. On Tuesday, we should get a monthly CPI of 0.3%, which would equate to an annualized inflation rate of 3.7%. Core inflation, which excludes food and energy, should be in the 5s, which is still high, but not high enough for the Fedheads to continue making speeches involving endless hikes. A bullish shock could likely undo some of the recent rally in equities, but not most of it.
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