Will the Bond Market be Able to Handle Brewing Price Inflation?

CAMS Weekly View from the Corner – Week ending 3/5/21

March 8, 2021

Since late fall we have seen tremendous price trends in many areas of the economy.  At the same time we have seen consistent action steps out of D.C. to fan significant amounts of money into the economic system.  We seen a $900 Billion package passed just in December and now a soon to be released $2 Trillion package.
 
Just two weeks ago, while discussing the current $2 Trillion package the Senate Majority Leader stated in their caucus he directed members to begin drafting an additional legislative package for various infrastructure and training stimulus to the tune of $3 Trillion. 
 
As a general pricing run through, since late fall, a broad swath of price trends have developed.  A non-comprehensive list includes Soybeans up 33%, Corn up 35%, Wheat up 15%, Gasoline up 32%, Copper up 29%, Lumber up 71%, and oil up 65%. 
 
The more comprehensive Thomson Reuters Equal Weighted Commodities Index is up 25% in this time-frame and has easily taken out its decade long downtrend handily to the upside.
 
This has been against a backdrop whereby society at large has remained in various forms of shutdown.
 
 
More Money Chasing Fewer Goods & Services
 
The shutdowns have resulted in fewer goods and services while money has been printed and fanned out consistently.  This elicits the old adage more money chasing fewer goods equals higher prices.  But the money has been relatively dormant via the shutdowns.  What happens with price inflation when society is not shutdown and the money is no longer dormant?  That is a recipe for notably higher price inflation.
 
Citizenry actions have shown up in two interesting areas of which Americans are certainly not known for:  Savings and (lack of) Consumer Debt. 
 
Consumer behaviors in the previous year have become “un-American” if you will.  That is, the Savings Rate has catapulted and held the highest levels we have witnessed in many decades while the growth rate in Total Consumer Credit has been zero.  In the case of Revolving Credit (credit cards) their growth rates have been trending negative for months! 
 
Is this a prototypical “new American” we are witnessing in the collective or are they taking a breather before resuming well established finance/consumption behaviors?    
 
History provides us with countless examples of significant societal behavior changes after a notable shock that occurred to a society. 
 
A global shutdown of society certainly qualifies as a notable historical societal event.  Is it enough to shock into existence a new collective finance/consumption behavior?  We watch with interest because if so it will impact various markets in various ways.   
 
 
Back to the Bond Market
 
For the bulk of our 2021 Weekly Views we have been consistently weaving nearly every topic through the bond market and we continue to do so again in this edition.
 
The current year-over-year Median CPI is at 2.1%.  This is a good barometer for the broad price inflation landscape. 
 
If you purchase a 10 Year Treasury bond your yield will be approximately 1.5%.  So the current referenced price inflation is running north of 2% and the Treasury instrument will pay you interest of 1.5%.  The stated price inflation is higher than your interest yield.  Does this sound appealing?  It gets worse.
 
Think of the general price inflation landscape shared above with input prices across the board rising rapidly.  It is fair to say those input price increases will show up, to whatever degree, in the price inflation measures and in so doing will make that 1.5% interest payment look even paltrier.  Sadly, it gets even worse.
 
Bond market participants can add up all of the above and much more and easily conclude they need a higher interest rate than 1.5% to be compensated for all of the new issuance risk (from the numerous stimulus packages shared above) as well as the general price inflation risk from all of the money printing.
 
This additionally equates to downside price risk for 10 Year Treasury bonds in light of participants choosing to sell.  In so doing, as bond prices move lower the yield (interest rate) moves upward. 
 
So as an investor you not only have an unfavorable interest rate level being paid to you relative to the price inflation backdrop but also have a real potential risk of loss in light of the prospects for downside price trends continuing on from here.
 
 
The Stock Market
 
We have questioned consistently that as pressure builds in the bond market, via the above general landscape, will the stock market be able to hold up?  More specifically, if the bond market begins to really trend downward from here, hence leaving a trail of consistently higher interest rates, will the stock market be able to handle those consistently rising interest rates? 
 
Thus far, the higher interest rate trend has begun to get the stock market’s attention in recent weeks.  In various areas within the stock market there is notable downside pain being experienced.  It seems foolish to think that if the bond market continues to notably crack to the downside in price from here that stocks will be able to consistently trend higher.
 
We continue to share our focus on the bond market with a deeper look into the general economic backdrop, as shared above, in that how the general price inflation story-line can play back through to the bond market and on through to the stock market. 
 
For our part, we continue to watch the bond market closely for additional guidance on all markets.
 
I wish you well…

Ken Reinhart

Director, Market Research & Portfolio Analysis

Footnote:

H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP).  This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”.  A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.