Bull Stocks, Bear Bonds: How Long Can the Rally Last?

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Hello, this is Bob Dahl with Dahl's Deliberations for September 8th, Issue 6.36.
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Stocks were mixed last week. The S&P eked out a small game.
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Focus continued to be on the rise in interest rates and higher oil prices.
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Best sectors were energy up 2.25% and technology up a little over 1%.
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Worst sectors, consumer discretionary down 2% and materials just shy of down 1.5%.
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Our essay is entitled, How Long Can a Bull Market in Stocks and a Bear Market in Bonds Coexist?
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Rising global bond yields are threatening to derail the liquidity-driven risk
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on climate that has boosted equities, corporate credit, and other growth assets since late 2023.
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In Jackson Hole, Fed Chair Warsh underscored that a higher policy rate may be
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necessary to reduce broad-based inflation pressures and bolster Fed credibility.
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There are signs of increasing angst about AI, with CDS spreads on several major
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players continuing to rise.
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Recent renewed military action by the U.S. and Iran add to near-term upside
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risk for oil prices, inflation expectations, and bond yields.
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The challenge for policymakers and investors is that bond market fundamentals
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are poor, with large government budget deficits adding to already elevated debt
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levels and bumping up against high and rising private sector borrowing.
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Absent an economic downturn, the path of least resistance for bond yields is up.
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There is no specific level at which government bond yields would trigger a downturn
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in the global economy and equity markets, But investor concerns will likely mount if the U.S.
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10-year Treasury yield looks poised to breach the 5% level last reached in October of 23,
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The less widely traded 30-year Treasury yield has already risen above its October
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23 peak and constitutes a warning sign We expect the U.S.
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10-year yield to rise above 5% at some point in the year ahead As always,
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the speed at which it rises may be as important for capital markets as the level
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that it reaches Thank you.
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These warning signs coincide with
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and are apparently driven by the ongoing resilience of the global economy.
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The latest batch of PMI surveys highlighted the global economic momentum is
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improving, despite notable headwinds including the Middle East War.
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Corporate profits are booming and support corporate equities and credit.
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We continue our recommended tilt toward international markets.
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While all equity markets will be sensitive to the AI trade, the U.S.
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Market is most vulnerable given its high technology concentration risk and elevated
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valuations and earnings growth expectations.
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Equity investors have been rewarded for being underweight the U.S.
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Over the past two years, a trend we expect to persist.
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Our forecast of a U.S. weaker dollar will further boost non-U.S.
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Equity relative performance.
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The upcoming U.S. midterm elections have the potential to inject volatility
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into markets in the near term, with Democrats favored to win control of the
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House of Representatives and possibly even the Senate.
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We doubt major legislative changes are likely if the Democrats win either or
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both Houses of Congress, but such an outcome could add to longer-term policy
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uncertainty ahead of the presidential election in 2028.
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Our 10 points for the week. Number one, The August payroll report meaningfully
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beat expectations, 167,000 jobs versus expected 55,000.
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This was just the opposite of last month.
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Unemployment was unchanged at 4.1% and average hourly earnings increased 0.3%.
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We argue that the inflation reports this coming week will be key to the Fed's
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rate decision later this month. 2.
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U.S. manufacturing expanded for an eighth straight month in August.
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Factories continue to lean on resilient consumer demand, solid business investment,
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but tariffs and the war-driven spike in energy prices are increasingly visible in the details. 3.
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Underlying U.S. inflation remains sticking, holding at least a half a percentage
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point above the level consistent with the Fed's 2.0% target.
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Number four, Fed Governor Waller said he's willing to hold the policy rate steady
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if progress toward the Fed's 2% inflation target continues.
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He also stressed that it would not take much evidence of persistent inflation
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pressures to support a hike.
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As mentioned, the burden of proof is now on the inflation data to justify a hike 5.
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The current unemployment rate at 4.1% is the lowest it's been in 18 months and
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is also lower than it has been 88% of the time over the past 50 years 6.
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The 30-year mortgage rate has climbed to 6.66% up from 5.98% in early March,
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High mortgage rates have left new buyers scrambling to afford a home and existing
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homeowners trapped in homes with low mortgage rates 7.
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Strong capital spending, in part reflecting the AI build-out,
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has contributed significantly to U.S.
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Economic growth in recent quarters But the CapEx cycle seems to be maturing
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The elevated level of CapEx also signals further upside pressure on corporate
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buying, interest rates, and inflation 8.
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Economic expansions rarely die of old age As they say, they get murdered by
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a central bank that raises rates significantly to fight inflation 9.
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The torrid pace of earnings growth is unlikely to last beyond the next couple
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of quarters As companies will face tough year-over-year comparisons in the first half of 2027,
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This could leave the equity market vulnerable to more volatility in the months
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ahead as equity supply increases and bond yields face additional upward pressure
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due to the growing demand for capital and sticky inflation.
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And number 10, when the S&P 500 is up 10% plus through August,
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as it is this year, a negative September to December has occurred only once
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out of 28 times since 1950.
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So our conclusion, the macro backdrop and rising corporate earnings point to
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further upsides for stocks versus bonds on a 6 to 12 month horizon.
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Yet, with the Fed and other major central bank expected to be hiking interest
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rates in the year ahead and bond yields still bias to the upside,
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the path ahead is likely to be
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increasingly challenging with lower returns than over the past few years.
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Equities would be increasingly vulnerable if earnings momentum rolls over beginning
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next year and or bond yields continue to rise. Thanks. Have a great week.
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That concludes this week's Dolls Deliberations. You now have our essential insights
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to start your week informed and prepared.
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