We’ve been talking a lot about this chart this year.
It shows the 1-year performance of the S&P 500 (green line) and the 10-year Treasury yield (orange line).
It seems like a contradiction. If stocks are rising — suggesting increased growth and inflation expectations — then shouldn’t Treasury yields be rising too?
In a note JPMorgan’s Hajime Kitano offers up an antidote chart. (HT: @dutch_book)
So basically, the connection is not between stocks and yields, but between PE ratios and yields, and although the stock market has been gaining, that’s apparently not been due to significantly higher PEs.The good news for equity investors is that, at least as Kitano sees it, long-term rates are likely to rise (thus pushing up PE ratios.
No matter whether the FOMC participants (1) take their hints from the stock market
and project the first rate hike for 2012, or (2) project it for 2014, in line with the
financial markets, US long-term rates are likely to rise, in our view. Under case (1)
expectations from monetary policy would have to be revised dramatically. Case (2)
would likely have an impact on inflationary expectations, in our opinion.
Incidentally, the yield on Italian government bonds at the time of the FOMC
statement in August, when the FOMC did not expressly mention the European crisis,
was 5.178%. In September, when the FOMC expressly mentioned Europe, it was
5.758%. The yield on Italian government bonds, which had temporarily exceeded
7%, had declined to 6.247% by the end of last week.
If the yield on Italian government bonds falls to under 6%, the FOMC will need to
revise its view that ‘Strains in global financial markets continue to pose significant
downside risks to the economic outlook,’ which it has maintained since September
last year. This should at least alleviate the basic concerns. Alternatively, if the FOMC
should not change its view in any way, its conservative attitude will, on the contrary,
stimulate inflationary expectations and via this route cause interest rates to rise, in