FLASH
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Why is fear spreading in the financial markets? Investors are beginning to face the reality that high interest rates will be long-term, writes The Economist
According to the poet TS Eliot, April is the cruelest month. Shareholders would disagree. For them, the cruelest month is September. Stocks in the rest of the year usually go up.
Since 1928, the ratio of monthly gains to losses in America's S&P 500, excluding September, has been about 60/40.
But the fall chill seems to be taking a toll on the market's psyche. In September, the indicator dropped to 55% of cases. Even this year, after the momentum of August, the indicator fell in the last weeks.
Such a calendar effect contradicts the idea that financial markets are efficient. After all, asset prices should only move in response to new data (for example, future cash flows). Predictable fluctuations must be recognized, exploited and managed by traders.
However, this September there is no secret about what is happening: investors have learned, or rather accepted something new: that high interest rates will continue for a long time.
The decline was driven by a series of monetary policy announcements, starting with an interest rate hike by the US Federal Reserve, which was followed within two days by 11 other central banks. Almost all the big banks repeated the message that high rates would be persistent.
Earlier, Huw Pill, of the Bank of England, had compared interest rates to the top of Table Mountain, a flat mountain peak in the African city of Cape Town, to distinguish it from the rugged Matterhorn mountain in the European Alps.
The President of the European Central Bank, Christine Lagarde, raised interest rates and spoke of a "long race". The governors of the Federal Reserve had thought that the base interest rate (which is now 5.25-5.50%), would cross the 5% mark by the end of 2024.
Expectations
For the bond market, these developments simply confirmed the expectations that had been created over the summer. The two-year Treasury yield, which is sensitive to short-term expectations of monetary policy, has risen from 3.8% in May to 5.1% now.
Long-term rates have also risen, and not just in America, where the ten-year Treasury yield has hit 4.6%, the highest level in 16 years. Ten-year German Bunds are now yielding 2.8%, the highest at any time since 2011.
British gilt yields are approaching last autumn's levels, which were reached only because of sales at low prices and the market falling.
At the same time, the Dollar has strengthened, driven by America's strong economy and the expectation that its rates will reach a higher level than those of other countries. The DXY, a gauge of the dollar's value against six other major currencies, is up 7% from a dip in July.
Compared to the bond and foreign exchange markets, the stock market has been slow to accept the idea that high interest rates will continue for a long time.
It is true that borrowing costs are not the only driver. Investors have been very enthusiastic about the potential of Artificial Intelligence and the resilient US economy.
In other words, the prospect of fast earnings growth could be a reason for the bullish stock market despite tight monetary policy.
However, it appears that investors had a very optimistic view of interest rates as well, and not just because the latest price drop was triggered by statements from central bankers.
Since stocks are riskier than bonds, they should offer a higher profit return as a reward. Measuring this additional expected return is difficult, but can be approximated by comparing the stock market's earnings yield (expected earnings per share divided by the share price) with the yield on the most expensive bonds. government securities.
The gap
If we apply this to the S&P 500 and ten-year Treasuries, the yield gap between the two has narrowed to just one percentage point, the lowest level since the dotcom bubble.
One possibility is that investors may be so confident in the underlying earnings of their stocks that they do not require any additional returns to account for risk in the event that these earnings turn out to be disappointing.
But that would be a strange conclusion to draw from economic growth which, while robust, has not completely escaped the business cycle, as disappointing recent consumer and household confidence data show .
Nor does it seem likely to explain the gains associated with Artificial Intelligence, a still-developing technology whose effect on firms' bottom lines remains unproven.
The alternative is that, until now, investors simply did not believe that interest rates would stay high for as long as the bond market predicted and central banks claimed. If this is the explanation and they have already begun to waver, then the coming months could be even more cruel./Monitor
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