Will You Win Or Yield?
In 1987, everyone yielded, 2018 is no different.
In a week where the trade war remained ‘phony’ and the most notable event was the ECB’s meeting to determine European monetary policy, it was US yields that dominated. But ironies abound in this market. Not least the same sequence of market events as 1987.
This week’s newsletter focuses on the relationship of the different asset classes and how an almost identical interaction to 1987 should guide us clearly from here into a stock market crash.
US Yields also dominated the markets of 1987. Although that year is obviously remembered for the October crash, it was the collapse in US bonds that accompanied the blowout and provided the background and trigger for the 40% sharp reversal in stocks.
And the comparison between 1987 and 2018 yields is striking.
As is the structural match of the current rally from March 2018 to last September-October.
Just as now, solid enough earnings and economic growth fuelled inflationary expectations and the belief the Fed was not acting quickly enough. And yet neither GDP nor inflation were rising in line with these expectations. The comparison between real 10 year yields and now is also worth noting.
It was the ramp above 9% in 10 year yields in 1987 (we have long argued 3% in 2018) that triggered the stock market turn and collapse.
Yields and Stocks
The combined uptrend of rising stock and yields characterised the last leg of all three of the 1920s 190s and 2010s bull market as expectations of inflationary growth continued to grow but failed to materialise.
Indeed it was the final sentiment driven blowout in yields that triggered the stock market crash.. as stocks in 1987 had already topped. So although the interaction of stocks with bonds is very similar either stocks are lagging this time—as we have already noted probably due to VIX) or they have already topped. A higher correlation between NDX and the 10 year is instructive.
Counter-intuitive in 1987 as now as you would expect tech stocks to be most adversely affected by rising yields and have the weakest correlation. This explains the market’s surprise in this last earnings week as the likes of Amazon continue to make new highs with yields.
Yields and the Dollar
But it was the interaction of the US dollar that baffled many in 1987 and now as it has continued to decline while yields have rallied.
Just as back then, the Dollar is now rallying relatively strongly in a correction to the downtrend as yields blew out. And it was the Dollar that turned down first in a resumption of its downtrend leading the massive reversal in both bonds and stocks later (by 14 days). So not only is the Dollar unusually moving with bonds but it appears to be leading them in these latter stages.
And within the Dollar it was USDJPY that continued to lead the other currencies (by seven days) and therefore the whole shooting match.
Yields and Gold
Similarly, the market back in 1987 kept a close eye on Gold as a combined yield/risk aversion play and yet it remained relatively lacklustre and range bound even through the crash.
All eyes may be on the US yields as a possible driver of all markets. But if history continues to repeat itself with such unerring accuracy, then it is the Dollar that will lead us into the most momentous market of a decade. And it is by focusing on USDJPY that we will not only be ahead of the game but in a position to win it.
Here’s to making the very best.
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