Capital Markets Have Reached The ‘Singularity’

Most investors have lived (and died) by the adage that “there is no alternative” to equities for the last decade or more – as global central bank repression has forced every Tom, Dick, & Harriet into ever more risky assets in search of yield… or some return.

However, a funny thing happened when “don’t fight The Fed” began to mean doing something that the commission-rakers and asset-gatherers wanted it to mean – stock prices fell, bond yields rose, and inflation chewed up any real income gains the average-joe felt.

“This is the way” that markets have been for a year or so now to the point where something shocking has just happened.

While we all know you should never “cross the streams”, it appears we have reached the capital market equivalent of the ‘singularity’: rates, equities, and credit yields have all converged.

For the first time since 2001, 6-month US money closed above the earnings yield (1/PE) of the S&P 500.

Additionally, investment-grade (IG) credit yields are still above 6 month money as they have also been selling off, but the gap has narrowed substantially in recent months. This hasn’t inverted since 1980 but has got close in recent weeks.

Deutsche Bank’s Jim Reid explains why this matters:

Earnings yields were below 6m money for long periods in the 1980s and 1990s without it impacting equity returns too much until the peak inversion around the dotcom boom/bust.

One might argue that for most of the 1980s and 1990s, collapsing yields and real yields meant that both bonds and equities could rally in unison.

For credit though, this type of curve spread has been a good lead indicator of credit spreads. As this curve gets flatter, the higher the probability is of spreads widening over the next 18 months and visa-versa.

Intuitively, when yields on short-end money are competitive with longer duration risk assets, there should be more circumspect investment behavior with animal spirits slowly draining away. The front-end should become more attractive to the detriment of riskier ventures out the curve. This is why we think an inverted curve is such a good predictor of the economy over subsequent quarters.