All of Wall Street has been waiting for what happens when the Federal Reserve raises rates and the bond market becomes attractive again.
For years it’s been thought of as the next cataclysmic event in investing.
But what if it isn’t? What if everything is going to be fine?
Think about it: Over the last two weeks bond yields have spiked. Most market participants are blaming big fund managers trying to get ahead of the Fed. The stock market, however, hasn’t really been hurt that much as this has been going on.
So what if yields rise slowly, the stock market takes a few hits here or there, but for the most part it’s ok?
“Modestly rising rates is probably the best possible scenario for US stocks in my opinion,” said Dan Nathan, a veteran trader and editor of RiskReversal.
“If rates were to go back to the recent lows, it would be for very bad reasons, like a recession, or a flight to quality, which both in my mind would be bad for US equities. A quick rise would possibly cause an end to financial engineering manifesting itself in stock buybacks (see QCOM $US10 b bond deal yest to fund $US10 b stock buyback, when they already have $US30 billion in cash on balance sheet) or possibly the end to speculative M&A in sectors like tech and biotech.”
So not terrible, no? That said, that doesn’t mean there aren’t going to be hiccups.
Even in a bull market things can get ugly. For example, in 1998 the S&P fell 20% due to a currency crisis and the collapse of titanic hedge fund Long Term Capital Management. The tech bubble, however, didn’t pop for another 2 years.
“My working assumption is that everything is going to be fine, until something changes,” said Josh Brown, CEO of Ritholtz Wealth Management. “But just because everything is fine doesn’t mean everything is going to be fine all the time.”
The thing is, Brown said: “I think it will come from somewhere that no one is talking about. It’s not there aren’t risks, it’s just that you don’t know which one is going to be the one.”
And so this isn’t to say that the prevailing disaster scenarios Wall Street has been talking about for years have gone away. They haven’t. It’s just that the more people see examples of rising yields and a fairly stable stock market, the more this “it’s going to be ok” idea slips into daily conversations at steakhouses, by water coolers, and at lunches with clients.
“The concept of having a 3-4% GDP growth and slow rate growth is a 10% shot,” said Brian Kelly, founder of Brian Kelly Capital.
“The best we can hope for is the muddle along approach where we get flat growth and yields stay relatively low. Where companies continue to financially engineer and buy back stock… In the long run, that’s bad for the economy.” Kelly sees that as a 45% chance.
The other 45% doesn’t look any better.
“Another 45% is that people sell out of stocks and bonds together… You could get a stagflationary environment.”