Warnings for a secular bear bond market
For some time now, Bill Gross of Janus Capital (JNS) has been expressing his concern over the coming of a probable bear bond market. In his January investment outlook, Gross talked about the 2.6% yield level as being critical for the 10-year Treasury, a breach of which could result in a “secular bear bond market.”
In February, he expressed his skepticism about the real economy getting a boost from the Trump stimulus. “We’re stuck in a 2% real GDP world,” said Gross. In March, Gross cautioned investors of the “bumpy road” ahead.
The Trump mirage
In his investment outlook for April 2017, Gross again shed light on the fact that the 3% US growth story build-up under the Donald Trump administration is nothing short of a mirage. And if this fairy tale does come true, it could lead to:
- A levered rate of corporate revenue/profit increases
- A significantly higher P/E ratio, all else equal
Above is a chart depicting the historical relationship between US growth and the S&P 500’s (SPY) (IVV) (VOO) P/E ratio. Correlation between the two over the period March 1954 to March 2017 came out to be at 0.16. Over the past 20 years (1997-2017), the correlation calculates to 0.36. The direct relationship between growth and prices seems to have become more pronounced now than it has been in the past.
3% growth may lead to a future bond bear market
This implies that if the Trump 3% growth narrative was to turn into reality, we should see:
- Top and bottom lines for US corporations increasing at a highly levered rate, and
- Rising price-to-earnings ratios across the board.
A 3% GDP growth rate in the US would definitely send “an all clear signal to leveraged and growth-dependent risk assets such as high-yield bonds.” This would imply a warning of a future bear bond market (BND) (AGG) (HYG) as investors flee to cash-in the growth-induced price increases on offer in the stock market (SPY) (IWM) (QQQ).