allanswart/iStock via Getty Images
allanswart/iStock via Getty Images
The old adage is that as investors shirk risk, money goes out of the stock market and into the bond market. But not this time around.
For the first time in the post-war era, government bonds failed outperform stocks in an equity bear, Jim Paulsen, strategist at Leuthold Group, pointed out in a note Wednesday.
“The messed-up nature of this pandemic economy got us thinking about a short list of critical economic and financial market changes (some occurring post-pandemic but others now evident for several years) that have complicated the interpretation of conditions and require investors to figure out if the deviations are permanent or just temporary,” Paulsen said. “Do they represent a Brave New World or a transient Bizarro World?”
From 1945 in “each of the previous 12 bear markets, when a 20% stock market decline declared the Bear, bonds outdid stocks every time,” he noted. “Maybe it is the unlucky ’13,’ but in today’s experience, not only did the S&P 500 (SP500) (NYSEARCA:SPY) outstrip the bond market when it realized the -20% level in June, but it has continued to do so since then.”
It’s probably an anomaly, but could become more of a prevalent theme, he added.
“The reason stocks are outperforming bonds in today’s bear market is not only because bond yields rose substantially but also because yields were so low when the Bear began,” Paulsen said. “It’s possible that both of those attributes could be in place for the next bear market.”
“The 10-year bond yield (US10Y) started this year at about 1.5% (near a record-low coupon buffer) and has nearly doubled. In the next recession, where will the 10-year yield settle? Could it fall back to 1-1.5%, setting up the possibility that, without any meaningful coupon buffer, fears of an overheating economy trigger the next Bear and stocks again beat bonds?”
Inflation stickiness may hold the key. Paulsen said the inflation rate now is likely “apt to go back soon to its disinflationary range of recent decades.”
“In that case, bond yields with 1-handles may become commonplace, and the investment community could be pushed to find a new Bear Spray.”
ETFs: TLT, TBT, IEF, SHY, EDV, IEI, VGSH, VGLT, VGIT, GOVT, SPTL
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