The rally for everything. That’s what Tout TV calls it. For them, bull markets are like hurricanes: they love them.
Every day, different stock market indexes set new records. The rise in stocks has spread from technology-focused gauges to the S&P 500 Equal Weight index and the old Dow Jones Industrial Average (DJIA 0.09%). Even the Russell 2000 RUT -0.21%, which isn’t very big, has joined the rally and has even done better than its bigger brothers by this point in October.
But along with the rise in stock prices, things like volatility in stocks, bond rates, and gold prices have also gone up. That means there is too much of a good thing and some less good things behind the overall rise in different assets and measures.
Most of it is easy to understand when it comes to instability. If you haven’t heard, there’s an election coming up, which could make buyers a little nervous. Or at least it might make them buy insurance in the options market in case something unexpected happens, which raises the implied volatility of options.
That’s true even though, at least so far, this year’s October Surprise has been the lack of a pre-election surprise, according to Julian Emanuel and his team at Evercore ISI. Even if the election results are different, the Cboe Volatility Index VIX -5.65%, or VIX, which shows how volatile the S&P 500 is over 30 days, has gone up from the midteens in mid-September to about 20, which is a slightly higher level. When stocks are constantly going up, that doesn’t usually happen. But the races before both 2016 and 2020 were very unstable, the team said in a client note last week.
Because of mail-in voting and the chance of legal challenges in several states, this year’s election results may be delayed, writes Monica Guerra, a financial strategist at Morgan Stanley. This could make the market more volatile. That’s why investors have been protecting themselves against “tail risks” of who knows what in this race that has never been so heated. The Evercore ISI team also said that they have kept their core stock positions because they expect the upswing to start up again once the election is over, just like it did after the 2016 and 2020 elections.
And after the bull turned two years old on October 12, history points to a third good year for stocks, according to the research done by Nicholas Colas, co-founder of DataTrek Research. Twelve of the fifteen times that the S&P 500 had two straight years of gains, the gains carried over into the next year. The average gain in the third year was 7.3%, which was less than the long-term average of 11.7%.
If you take out 1937, which was a really bad year (the second downturn of the Great Depression, with a 10% drop in GDP), the average gain in the third year was 10.3%, which is close to the long-term mean. Good enough of a reason to stay involved even though the odds of election-related instability are low.
That being said, Yardeni Research said in a note on Thursday that the U.S. economy is “hot, hot, hot.” The Federal Reserve Bank of Atlanta raised its GDPNow estimate of GDP growth for the third quarter from 3.2% to 3.4% per year, taking inflation into account. It raised its estimate of personal spending growth from 3.3% to 3.6% after September retail sales were better than expected. Core retail sales, which don’t include cars, building supplies and petrol, went up 0.7% last month, which was more than twice the 0.3% increase that most people expected and more than double August’s 0.1% increase.
Teams Yardeni and I both agree that the Federal Reserve was too dovish when it lowered the federal funds rate by 50 basis points (0.5 percentage points) on September 18. “As soon as we heard about it, we increased the chances of a stock market crash and predicted a backwards move in bond yields.” The 10-year U.S. Treasury yield has gone up almost 50 basis points to 4.10% since September 18th, and stocks are rising to new record highs.
New results from the widely watched global fund manager survey from Bank of America’s strategy team, led by Michael Hartnett, show that investors’ confidence has risen the most since June 2020. This was caused by the Federal Reserve’s supersized rate cut. Money managers put more money into stocks and less into bonds and cash. It sounds like they’re all in, which could make buyers who like to bet against the crowd nervous.
Bond prices have gone down after inflation expectations have gone up almost as much since the Fed cut rates in September. That’s the biggest rise in five-year inflation swaps since Silicon Valley Bank went bankrupt in March 2023, according to a note from Jim Reid, global head of macro research and topic strategy at Deutsche Bank, that came out this week. But that doesn’t mean inflation is out of control, he said. “The story of a strong economy, a fairly aggressive easing cycle, and perfectly behaved inflation sounds more like a Christmas wish list than the most likely outcome.”
So, it shouldn’t be a wonder that gold prices finally went above $2,700 an ounce on Friday. This made the metal’s year-to-date rise to about 32%, much higher than the S&P 500’s 22% rise. Gold and stocks usually go against each other. Gold is a passive long-term store of value, while stocks are a claim on the future profits of active companies.
Michael Cuggino, manager of the Permanent Portfolio fund, said that there are conditions that can help both gold and stocks at the same time. The fund has target allocations to stocks, precious metals, and U.S. and Swiss franc fixed-income securities to lower the total risk of the portfolio.
The rate drops by the Federal Reserve Chair, Jerome Powell, have been called a “recalibration” of monetary policy. This has been good for both gold and stocks. As of now, the start of the third-quarter earnings reporting season looks pretty good, Cuggino said in an interview. There is a chance that stock prices are a bit too high, but profits are high and employment is high, so the market just “bleeds up.” But people are still buying gold, from Costco shoppers to central banks, he said, especially since the world is becoming more dangerous politically.
BofA’s commodity analyst Michael Widmer thinks there is another person to blame. Walt Kelly, who made the comic book Pogo, once said, “We have met the enemy, and he is us.” He wrote in a study report with the provocative title “Is gold a safer investment than Treasuries?” that the yellow metal is rising because of wasteful spending, mostly in the U.S.
For fiscal year 2024, which finished in September, the U.S. had a budget deficit of more than 6% of GDP. Widmer points out that neither former President Donald Trump nor Vice President Kamala Harris, who are running as Republicans and Democrats, “seem to prioritise fiscal consolidation.”
The Wall Street Journal’s Peggy Noonan said it best when she said that the presidential campaign had “reached its Oprah phase.” This is the time when TV star Oprah Winfrey would tell her studio audience, “You get a car, you get a car, you get a car.”
Both candidates are promising lots of good things, like not taxing tips, overtime, or Social Security and letting new businesses get loans that they can’t pay back. She wrote, “to whatever group whose love is immediately needed.”
The Congressional Budget Office predicts that the U.S. will have a deficit of nearly $2 trillion per year in the next few fiscal years. This is almost twice as much as they thought it would be in early 2021, as Widmer of BofA pointed out. That’s mostly because of the Treasury’s interest costs, which the CBO predicts will become bigger than the “primary deficit” (the budget gap excluding interest costs) by 2025, when the government can’t borrow money for almost nothing.
The bond market is where those shortfalls have to be paid for. “In the end, something has to give: If markets don’t want to take on all the debt and volatility rises, gold may become the best investment,” he said.
In particular, central banks could hold more gold instead of Treasuries. He said that the valuable metal now makes up 10% of their currency reserves, up from 3% ten years ago.
For now, though, foreign buyers are still buying Uncle Sam’s IOUs like crazy because they are easy to cash in. According to Wells Fargo’s analysis of Treasury International Capital figures released on Thursday, foreign investors bought $511 billion worth of Treasury notes and bonds from August to the end of the year. This was equal to 32% of the total amount issued.
But in the last four months, central banks have been net buyers while private investors have bought. Over the past six months, the central banks of Japan and China have lowered the amount of coupons they hold by $62 billion and $43 billion, respectively. Foreign investors have continued to buy short-term T-bills, though. They bought $59 billion worth in August, which was the most in a year, and $114 billion total over that time.
Certainly, the Fed lowering short-term interest rates while the economy keeps its “no-landing flight” is a recipe for higher prices on all kinds of assets, not just stocks. According to a note released on Friday by Diana Iovanel, senior market economist at Capital Economics, spreads on corporate bonds—the extra return for their perceived risk—are very close to record lows. This shows that investors are even more optimistic about the future of the economy.
Even though people are optimistic about the business and financial situation, the so-called “barbaric relic” gold keeps setting new records. Widmer thinks that the price of gold could drop if the Fed doesn’t cut interest rates, but he also thinks it could go as high as $3,000 an ounce.
According to the International Monetary Fund, all governments will have deficits that hit 7% to 8% of GDP every year by 2030. This includes the U.S. He ends by saying, “Gold may be the last perceived safe-haven asset standing if markets become unwilling to absorb all the debt and volatility rises.”
