Bond markets not buying this equity rally

Charlie Jamieson

Jamieson Coote Bonds

Bond markets aren't buying into the optimism seen in equity markets in any way, shape or form. So while the S&P500 index gained 4.5% in May, bonds didn't move much at all. The rally in risk markets has been an incredibly powerful momentum-based trade, but as we saw in March, that momentum can work in both directions.

We still feel that the rubber is yet to hit the road in regards to the fundamental situation, and The Federal Reserve Bank of Atlanta is now predicting that second-quarter US GDP could be more than negative 50%. 

We share our view in this short video with transcript and explain why now is the time to think about your asset allocation very carefully. 


What a salient reminder that markets are made up of many parts, both fundamentals, which we know are in dire shape as a result of COVID-19, technical factors, and certainly liquidity. And liquidity has been a huge part of the reason that markets have done very, very well over the course of May in terms of risk market performance.

We know we've had huge liquidity injections as a result of COVID-19 rate cuts and stimulus, but it really has been an incredible rally, an unexpected rally in many respects, from those liquidity provided levels. 

But we still feel that the rubber of the road must meet the fundamental situation later on. 

So we just caution investors to think through how this has been an incredibly powerful momentum-based trade, but that momentum can work in both directions, and we certainly saw that in March of this year. So do be careful and think through your asset allocations very carefully.

Interestingly, I think we had a similar period in the 2008 market year, where we had a sell-off in risk assets early on, followed by a rally that lasted around three months, before ultimately another sell-off. 

It's worth considering that period because, in 2008, the U.S. economy was 96% of the 2007 economy, i.e. the economy shrunk by 4%. That generated the largest recession we've seen since the depression of the 1930s. 

It's very likely that 2020 is far worse than a negative 4% of 2019. In fact, the FED now publication, the GDP now from the Central Bank or the Federal Reserve Bank of Atlanta predicts that second-quarter GDP could be more than negative 50%.

Now, clearly on a rate of change basis, as the economies reopen, we're going to see some staggeringly large growth numbers coming off such depressed numbers, but in totality, it's very unlikely that the economy can regain anything like of its 2019 levels.

We still have 42 million Americans that are newly unemployed, and reports in the media suggesting one in four Americans is skipping on meals or requiring food collections in order to feed themselves through the COVID-19 epidemic. 

So we still feel that underneath what has been an amazing recovery in terms of coming off the lows from the COVID-induced sell-off, there are some serious issues that we need to deal with.

UBI and MMT are here

It's interesting to us, I guess, how quickly the bar has been moved on many of these social or financial programmes with very, very little real debate. 

The universal basic income crowd and the modern monetary theory crowd were pretty widely denied under capitalist systems ahead of this time. 

But in many respects, both of those programmes are fully operational now. And they've been green-lit by folks that are unelected by the people, who have committed trillions of dollars to these programmes.

I think it's amazing how quickly this is all moving. We certainly know from prior episodes when we've had things like quantitative easing, we never got out of those programmes. So, will these programmes stick around? Will they change the fabric of society and the economic construct going forward? They're all interesting things to think about.

Clearly at the moment, we're seeing substantial violence around the world as a result of a catalyst, which has been race-based in the United States, but we think that there's more to this and we will continue to see this with vast swathes of people are on unemployment. 

Clearly governments have used this opportunity to bridge the cash flow of the situation, which is delaying some of the economic consequence. That's been a good thing, but we know here domestically, the government is very committed to removing and winding down things like job keeper and job seeker. 

So maybe the pain is in front of us still when these programmes of really disaster relief are wound down, and the realities of the day might be more evident than in the market kind of view.

Bond markets not buying this equity rally

Throughout the month, I think it's interesting to note that despite all of the optimism of risk markets, bond markets really aren't buying into this in any way, shape or form. 

That's not to say bond yields aren't moving a little bit, but broadly over the month of May, they didn't move much at all, and their returns across our funds suggest that with a slightly positive return in our domestic fund and a slight draw-down in our global funds. 

Clearly, the bond markets have long memories, and I think that now well realise that we're likely to see some volatility through the series, and the momentum in an algorithmic-based world is incredibly powerful and can be very difficult to stand in front of. But when it does roll over, I think then it does look more interesting.

And we would expect that this episode must meet a crescendo at some stage where that reality does kick back in.

For now, we're trying to open up economies. We're hoping that the virus doesn't come with us and we don't have large second wave outbreaks. Hopefully, we can get back towards the most optimised economy we can have in this frame, in this state of social distancing. We know the borders are likely to be closed. Travel, and tourism is going to be deeply affected in Australia. Our export of education and those types of things will be deeply affected. 

But thankfully, in Australia, we've done a great job on a health front, and hopefully, we can get closest to our optimised shape as quickly as possible. Thank you very much.

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Charlie Jamieson
Chief Investment Officer
Jamieson Coote Bonds

Charles is a co-founder of Jamieson Coote Bonds (JCB) and oversees portfolio management of the Australian and Global High Grade Bond and Dynamic Alpha investment strategies. Prior to JCB, Charles forged a career as a seasoned bond investor from...

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