@theMarket: If Bond Yields Continue Climb, Stocks Will Fall

Investors sold stocks, as bond yields reached new multi-year highs. Third-quarter earnings are almost an afterthought in this climate, and geopolitical events did not help either.

 

The 10-year, U.S. Treasury bond hit the 5 percent mark. The 30-year bond has already broken through that number and then some. The higher yields climb, the more investors fear that they will rise even further. As it stands now, the return you can get by putting your money in bonds is becoming more and more attractive versus stocks.

 

This is happening despite the cessation of long-term bond auctions by the U.S. Treasury this week. Short-term bills and notes have been auctioned instead. The next tranche of longer-dated securities won't begin again until November. You would think that with the pressure off yields, longer-term bonds would have rallied but they didn't.

 

The explanation is simple but also troubling. After years of ignoring the growing U.S. deficit, the financial markets are becoming worried that the government's continued spending is rocketing out of control. I have written about this in past columns, but it seems investors are starting to pay attention to the problem at long last.

 

A reader may wonder why it is so hard for politicians to corral their spending. The simple answer has nothing to do with whether we are talking about Democrats or Republicans. Two-thirds of U.S. spending is earmarked for just two programs: Social Security and Medicare. That's it, and no one in their right mind is going to cut back on those programs unless they want to lose their jobs.

 

That leaves a much smaller piece of the pie to squabble over. Liberals want spending to go to social programs and cut the rest. Conservatives insist it is spent on things like defense and investment instead. In a political landscape, where compromise has become a dirty word, the only answer is to keep spending more and more to satisfy the demands of both sides.

 

A great example of the conundrum we all face is President Biden's emergency funding request to Congress this week. The president is asking for $75 billion to aid Israel and Ukraine. There is another $30 billion he wants to fortify border security.

 

So, who among us is ready to say no to that kind of spending? Sure, some might, but most Americans and their representatives in the heat of the moment are going to want to approve those additional funds. But it was no accident, in my opinion, that when the president first announced this additional spending request on Oct. 18, the yield on the benchmark, ten-yield bond spiked even higher and hit a 16-year high.

 

The Chairman of the Federal Reserve Bank Jerome Powell gave little comfort to investors in a speech before the Economic Club of New York on Thursday. Some investors hoped that he might be willing to relax his monetary policies instead of the recent run-up in bond yields. Instead, Powell said inflation is still too high and warned that more interest rate increases are still possible if the economy stays strong, or if the tight labor market does not ease further.

 

The most he said about the recent surge in long-term bond yields was that "we remain attentive to these developments" acknowledging that if this situation persists "it can have implications for the path of monetary policy."

 

As for the continuing saga of failed governance among the Republicans in the House of Representatives, the facts speak for themselves. Rep. Jim Jordan, the radical politician and Trump lackey, has failed in his attempt to claim the position of speaker for a second time. His followers used social media to browbeat and threaten some Republicans into voting for him. That ruse backfired leaving him no choice but to try again on Friday. Once again, Jordan failed to convince his fellow legislators that, somehow, he had changed his stripes.

 

One hopes that he will accept the "three strikes you're out" verdict, but given his nature, he could very well claim the voting was fixed. He has done it before. The country remains in limbo as a result, with no progress in averting a government shutdown or aiding our allies around the world.

 

Last week, I said we were still in a bottoming process. I expected this period should have been over a week ago. It is still not done. I blame the Hamas terrorist attack in Israel for prolonging this process. I warned that we were going to test the low 4,300s on the S&P 500 Index. If the geopolitical events worsened (and they have) we could fall all the way down to the 4,200 area. That is just what we did. 

 

As of noon on Friday, we were trading 35 points above my low-end target. We bounced off the 200 Day Moving Average at 4,233, which was to be expected. Is it almost over, maybe? I still think we could go lower if the geopolitical news gets worse.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.