05.19.26 - Is it a good time to buy bonds?

Um, Jurrien, I feel like it was just yesterday I was asking you where are the bond vigilantes, though reacting to other things as well that we talked about, Julian, uh, like fiscal spending.

Um, a- and you, and you mentioned, Julian, that this can have an impact on other asset classes.

So Jurrien, let's talk about the impact on the stock market here because stocks have been surging thanks to strong corporate earnings up until now.

But the, you know, is the market now starting to shift more from focusing on the positives of strong earnings to focusing on the negatives of higher inflation? Uh, it-- or do you see this as a positive move, just, just like Julian? A- and what do you think this could mean for the bull market's run?

run?So, um, let me just unpack that a little bit.

So it's a little bit of a paradox that the, there are-- you know, we- we- we think about the bell curve distribution of outcomes, right? The, the right tail is, is a very good outcome, and certainly the AI boom and what it has done to earnings and capital spending and economic growth, uh, is clearly a right tail phenomenon.

The left tail, of course, is the bad outcome.

Um, and in today-- and, you know, oftentimes that bad outcome might be a recession or something like that.

But today it's really about inflation.

And, you know, we have this conflict in Iran, and it's now, what is it, like eight weeks old.

And, uh, when it started, the market thought, okay, this will last a couple of weeks, and then oil prices will go down and, you know, and we can all go back to business.

That has not happened.

Oil is still at $108 a barrel, and, uh, and the longer that lasts, the more the inflation creep kind of goes into the global economy.

So we have a right tail, which is bullish, a left tail, which is bearish.

Another way of thinking about this is you have earnings which are on the right tail because they're growing by over 20% per year, which is of course very, very strong.

Um, we have valuation on, on the equity side, so the P/E ratio, which can be driven, uh, or influenced by bond yields.

And when bond yields rise as they are now doing, um, and the, the yield on what we think of as the risk-free, as, as the, as the, as the risk-free assets, right? So the safest asset, treasuries, um, is very competitive with the yield or the inverse of the P/E of the stock market.

And so when that happens and stocks and bonds are positively correlated as they are today, uh, rising yields will, will, will force valuations in the stock market, uh, to come down.

Uh, so you have earnings, you have valuation.

At the intersection of those two is price.

So when you think about the Dow Jones or the Nasdaq or the S&P, most people will look at the price index, uh, but the price is just the intersection of the two.

So what we've been seeing over the last few months with this, uh, conflict in Iran is the valuation goes down because oil prices produce inflation, and inflation causes yields to rise, and rising yields when they are competitive to stocks, will cause the equity P/E to come down.

Uh, but earnings are booming, and as a result, price, the S&P 500 price index is somewhere in between.

And that's why we only saw a 10% correction in the stock market, even though the P/E ratio went down almost 20%.

So that's how I think about the intersection of stocks and bonds and why one has an impact on the other.

Um, Jurrien, I feel like it was just yesterday I was asking you where are the bond vigilantes, though reacting to other things as well that we talked about, Julian, uh, like fiscal spending.

Um, a- and you, and you mentioned, Julian, that this can have an impact on other asset classes.

So Jurrien, let's talk about the impact on the stock market here because stocks have been surging thanks to strong corporate earnings up until now.

But the, you know, is the market now starting to shift more from focusing on the positives of strong earnings to focusing on the negatives of higher inflation? Uh, it-- or do you see this as a positive move, just, just like Julian? A- and what do you think this could mean for the bull market's run?

run?So, um, let me just unpack that a little bit.

So it's a little bit of a paradox that the, there are-- you know, we- we- we think about the bell curve distribution of outcomes, right? The, the right tail is, is a very good outcome, and certainly the AI boom and what it has done to earnings and capital spending and economic growth, uh, is clearly a right tail phenomenon.

The left tail, of course, is the bad outcome.

Um, and in today-- and, you know, oftentimes that bad outcome might be a recession or something like that.

But today it's really about inflation.

And, you know, we have this conflict in Iran, and it's now, what is it, like eight weeks old.

And, uh, when it started, the market thought, okay, this will last a couple of weeks, and then oil prices will go down and, you know, and we can all go back to business.

That has not happened.

Oil is still at $108 a barrel, and, uh, and the longer that lasts, the more the inflation creep kind of goes into the global economy.

So we have a right tail, which is bullish, a left tail, which is bearish.

Another way of thinking about this is you have earnings which are on the right tail because they're growing by over 20% per year, which is of course very, very strong.

Um, we have valuation on, on the equity side, so the P/E ratio, which can be driven, uh, or influenced by bond yields.

And when bond yields rise as they are now doing, um, and the, the yield on what we think of as the risk-free, as, as the, as the, as the risk-free assets, right? So the safest asset, treasuries, um, is very competitive with the yield or the inverse of the P/E of the stock market.

And so when that happens and stocks and bonds are positively correlated as they are today, uh, rising yields will, will, will force valuations in the stock market, uh, to come down.

Uh, so you have earnings, you have valuation.

At the intersection of those two is price.

So when you think about the Dow Jones or the Nasdaq or the S&P, most people will look at the price index, uh, but the price is just the intersection of the two.

So what we've been seeing over the last few months with this, uh, conflict in Iran is the valuation goes down because oil prices produce inflation, and inflation causes yields to rise, and rising yields when they are competitive to stocks, will cause the equity P/E to come down.

Uh, but earnings are booming, and as a result, price, the S&P 500 price index is somewhere in between.

And that's why we only saw a 10% correction in the stock market, even though the P/E ratio went down almost 20%.

So that's how I think about the intersection of stocks and bonds and why one has an impact on the other.