Trading Desk: Fear Walks, Money Talks

We’ve talked a lot about walls of worry in the last few months as Wall Street fixates on every possible sell signal: long-term yields are high enough to lure money out of stocks, the economy is too hot to kill inflation but a recession feels imminent, earnings growth has stalled, a government shutdown now looks likely if not probable.

But when you dissect the logic behind each of these fear factors, the motive really boils down to people who are tired of stocks looking for an excuse to walk away. That’s it. One way or another, the market is no longer fun for these investors. I get it. Last year was grueling and the last few months have reopened a lot of emotional wounds for people who have lost their appetite for volatility whether it leads to a rewarding payout or not.

After all, the economy can’t be simultaneously too hot and teetering on the brink of a catastrophic recession. That’s just not how numbers work. To reverse direction, you have to at least temporarily slow to a halt and then start moving at negative velocity. And the tangible absence of that reversal is what keeps the Fed from lowering short-term rates.

Any shutdown in government spending will accelerate that slowdown and give the Fed room to give us all rate relief. Lower short-term interest rates, in turn, take the pressure off long-term bonds, which are as far from it gets right now from sucking money out of the stock market the way some people dread. Remember, bond yields go DOWN when demand for Treasury debt increases beyond available supply.

We are seeing the exact opposite of that scenario play out here in real time. Nobody is leaping to lock in even 4.5% yields for the coming decade when inflation is still running at 3.9% a year. That’s simply not a level where bonds have historically been attractive, and our end of the stock market is equally simply not responding in any way that lines up with a flight to bonds.

Guess what? Any time Congress pushes the limit on funding the government, confidence in Treasury debt erodes and appetite for bonds goes down. I wouldn’t want them here either. Bonds were never any competition as far as we were concerned. That’s a false narrative.

People buy bonds because they want to lock in a known coupon rate and are willing to accept the fact that their return is unlikely to ever exceed that level. That’s why these are called “fixed income” instruments. That’s why you lock in a yield and your future is truly locked in from there.

People buy stocks because we want to dream a little higher and because companies are more than dead paper. They’re practically living entities, with the ability to innovate and surprise us to the upside. They’re open to hope, optimism and old-fashioned human potential.

When they fail, they fall harder than bonds. But enough of them succeed to keep raising the bar, year after year and generation after generation. Consider: bonds have historically needed to pay about 3% above inflation to be attractive. That’s generally a yield of 5.5% to 6.5%.

Stocks have historically rallied about 8% above inflation That’s generally an annualized return of 11% or so. Some years are bad. Some are much, much better.

Right now, our stocks are moving in the “much, much better” category. To be honest, so is the broad market. Despite all the dread in the air, the S&P 500 is up almost 20% in the past 12 months. Even adjusted for ambient inflation, that’s actually a pretty good year.

If you fled to bonds a year ago, congratulations. You spared yourself the occasional storm of volatility on Wall Street but you ended up cashing about 3% in interest. Not enough to even keep up with inflation.

Bonds are dead. Lately they’ve been dead money as well. Nobody who bought 30-year bonds in the last decade is eager to settle for 1.5% yields or worse. The Fed’s 2% inflation target guarantees that you will lose money on that bet.

Now I think you see why yields are rising. It’s because existing bonds are such a bad deal that people are fleeing that market. They’ll keep fleeing. And as they do, our stocks offer a competing and better vision of the future.

And if any of them falter, the math is still our friend. The portfolio as a whole moves up. Individual stocks move up and individual stocks move down. Enough of ours are moving up aggressively enough that the bar keeps rising.

Let the index funds worry about the companies that dominate the indexes. Those companies aren’t growing. They have room to fall. If I’m a shareholder in Mega Tech, maybe it makes sense to get out and lock in 4.5% interest for the long haul.

But we don’t own Mega Tech here. We own the Mega Tech of tomorrow. That’s the difference.