November 1, 2020 – Weekly comment

There has been a lot of talk recently about the future of the 60/40 portfolio mix.  The breakdown of that particular strategy was on vivid display on Friday, the last trading day in October.  On the month, SPX fell from 3363.00 at the end of September to 3269.96, a decline of 93 points or 2.7%.  The US treasury ten year note yield went from 68.5 bps to 85.4 bps, a rise of just under 17 bps, which represents a 24.7% increase in the yield.  TYZ0 had the lowest settlement since early June at 138-07 on heavy last-minute end-of-month rebalancing volume.

Since the end of 2007, the onset of the Great Financial Crisis, there have been very few months when yields rose while stocks fell.  I have taken data from Bloomberg, available on request.  Over 156 months, in only 16 months, about 10% of the time, was SPX down over 1.5% accompanied by a rise in the ten year yield.  The average yield increase on these occurrences was 13.6 bps.  However, of these 16 cases, the percentage change in yield is the greatest in the current month.  Of course, it makes sense, as most of the time, yields on the ten year were above 2%.  It’s only this year that we’ve had yields under 1%, and now the market perceives that as a strange ceiling of some sort. 

Obviously, when the yield is above 3%, as it was the last time this happened in October of 2018, an 8 bp move from 3.06% to 3.14% isn’t that big of a deal, although SPX fell 6.9% that month.  This was the time that the Fed was hiking, both in terms of raising the Fed Fund target, and in terms of increasingly paring back its balance sheet.  The beginning of October is when Powell famously said “we’re nowhere close to neutral” at the same time the taper program was ratcheted up to $50 billion per month from $30 billion and $40 billion the previous two quarters.  The last straw. SPX fell 6.94% and the ten year yield rose 8.2 bps to 3.144%. This period in Q4 2018 led to an about-face in 2019.  The Fed to the rescue.  From its own blunder.

Let’s look at the other two times the percentage change in yield was closest to the current with SPX down 1.5% or more.  In June of 2013, SPX had fallen exactly 1.5%.   The ten year yield went from 2.13% to 2.49%, the largest jump in terms of bps, a total of 36.  The percentage change in yield was 16.8% (smaller than the current experience).  What was the catalyst?  Why it was Ben Bernanke of course, who sparked the taper tantrum in May 2013, throwing markets into a brief tailspin as what was considered to be a QE promise had the rug pulled from under it.  The other episode was October of 2016.  SPX fell 1.94%, with Hillary expected to handily win the election.  Sound familiar?  The ten year yield increased that month from 1.595 to 1.826, or 23.1 bps, which translates to a percentage increase of 14.5%.  Of course, we now know the outcome for stocks post-election: 14 out of 15 months of gains, with only March of 2017 registering a -4 bp blip.

Are there conclusions to be drawn about the portfolio mix?  Nothing definitive from as cursory a study as this.  The intuitive suspicion that many analysts have voiced is that bonds at sub-1% yields don’t provide protection, or even a thin cushion, for one’s stock portfolio.  This limitation is more keenly acute given the Fed’s repeated opinion that negative short term rates are not an appropriate policy response for the US economy.  That point was further expanded upon by former NY Fed President William Dudley, who helpfully told BBG on October 28 that the Fed was nearly out of firepower.  “It [the Fed] can even take interest rates negative (a move that Fed officials have so far rejected).  But this misses a crucial point.  Even if the Fed did more – much more – it would not provide much additional support to the economy.”  Hence the continued Fed pleas, even from the sidelines, for fiscal measures to plug the holes that are still leaking from covid.

In a nod to the perceived shortcomings of bonds as a safe counterweight to equity market volatility, some have allocated more to precious metals, or to bitcoin, or even to the biggest cap tech stocks as a store of value.   This of course, only increases pressure on the Fed to buy more treasuries.

This is when you run for the cover of very short maturities, not thinking that capital gains or coupon payments do anything for you.  Simple capital preservation.  As my friend Larry used to say, I don’t want the cheese anymore, just help me get my head out of this trap.”  Of course, even that course of action is not so attractive when the Fed is more or less shouting from the rooftops that it wants a cheaper dollar. 

This is the big week:  Election day, Treasury refunding announcement, Fed meeting, Employment Report.


Note that nearly all measures of the curve are at or near the highs for the year.  2/10 closed Friday at 71.3, a new high.  5/30 closed 1.264, within a couple of bps of the year’s high.  Red/gold euro$ pack spread settled 60 bps, a couple bps off the year’s high of 62 on June 5.  Another old trading rule:  when a market goes into a big number or event and is at an extreme level, it usually continues that trend. 

Good luck this week!

UST 2Y15.715.2-0.5
UST 5Y37.738.10.4
UST 10Y84.086.52.5
UST 30Y164.5164.50.0
GERM 2Y-75.8-74.41.4
GERM 10Y-57.5-62.7-5.2
JPN 30Y64.064.30.3
EURO$ Z0/Z1-1.5-0.51.0
EURO$ Z1/Z210.010.00.0
EURO$ Z2/Z318.517.5-1.0
CRUDE (active)39.8535.79-4.06
Posted on November 1, 2020 at 8:51 am by alexmanzara · Permalink
In: Eurodollar Options

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