QE Unintended Consequence #1: Bond Bubble burst or Rapid Rise in Interest Rates
Everyone is talking about interest rates for 2 reasons:
1. Because of the velocity and magnitude of the move in such a short time.
2. Because it is happening alongside an equity correction (3% in SPX).
Why is this happening?
1. “Taper” or the decline of the largest UST buyer since 2008. Now bonds have to find fair market value which will probably be volatile as the process of price discovery takes time.
2. An improving global economy led by the US. Whether or not you believe the US, China, Europe or Japan recoveries are real it seems like sentiment has shifted optimistic.
3. Momentum of the herd psychology. Just like we witnessed in AAPL this year bonds are under-going a cycle shift from bull to bear.
So where are interest rates going?
Classic answer is no one knows but if I were a betting man higher than here longer-term if the economy is definitely on sustainable or at least stable ground.
However interest rates are at short-term resistance and bonds are oversold from a technical and sentiment standpoint. Also we are nearing a critical point for interest rates where any further rise could hurt the real economy. Businesses and potential home owners see a rapid erosion to their access to credit and buying power and interpret the volatility as more evidence to adopt a wait and see hunker down approach to investment.
Yes the market is on a tear. It’s in a bull market yada yada yada…
On average August returns are slightly negative -.01%.
It is common knowledge that August is seasonably weak along with September. Below is a chart of SPX returns from 1980:
Here what historically has happened when SPX finished July over 5% and over 15% for the year through July.
So odds favor a pullback into August with a 60% probability that August closes red and average return of -1%.