By Daryl G. Jones, Hedgeye
FORTUNE -- Every quarter, our team here at Hedgeye gets together and boils down the turmoil in global macro markets to three neat and tidy themes for our clients. But, in the spirit of Gary Keller's new, thought-provoking book, The ONE Thing, I'm going to employ a little alchemy and distill our team's latest macro toil down to one key theme: rising rates.
Consider the following three noteworthy items on rising interest rates:
The Queen Mary of macro trends has inflected. We often use the analogy of the Queen Mary turning to describe the long-term trend in interest rates. The Queen Mary, of course, was the massive ocean super liner that dominated transatlantic voyage before the jet age. As is the case with any vehicle that is more than 300 meters in length, turning the Queen Mary around was no easy task. And certainly not without wide-reaching implications and reverberations.
This particular analogy is especially appropriate for the current sea change in interest rates, as they have literally been in decline for the last three decades, since peaking in the early 1980s. This long-term decline has enabled virtually any business that depends on borrowing money to fund its business to have a steadily declining cost of capital. In addition, this has made bonds a compelling asset class for investors.
In our second-quarter models, yields inflected notably and broke out above our TRADE (three weeks or less), TREND (three months or more) and TAIL (three years or less) levels. This is nothing to sneeze at. In fact, as shown in this Chart of the Day, 10-year yields had their largest percentage increase quarter over quarter in more than a decade. Even though 10-year yields have broken out, they remain well below the mean yield since 1989 of 5.21%. In other words, despite their recent rise, yields are still around 260 basis points off the mean.
The market is chock full of debt. Given the generational trend in interest rates going lower, and thus providing a tailwind for bonds, it should come as no real surprise that a large percentage of investors' portfolios are full of fixed income. According to the most recent data, there is $38 trillion of bonds outstanding across all subsectors of the bond market. Moreover, bonds outstanding have increased every single year since 1990.
The more critical data point from an asset flow perspective is that the notional value of bonds outstanding is currently at 68/32 vs. the market capitalization of equities. This, too, is an extreme ratio based on history and is literally the highest we have seen. For comparative purposes, this ratio was at 50/50 as recently as 1999.
Volatility and duration across the bond market are in a setup that could lead to meaningful losses. As volatility in an asset class increases, so too does the expected loss and/or return. According to Merrill Lynch's MOVE index, bond volatility has almost doubled in the last quarter and is at two-year highs. Meanwhile, duration is at close to all-time highs. My colleague Jonathan Casteleyn of our financials team highlighted this in his recent presentation on asset managers, but based on current duration, a roughly 100 basis point move in yields equates to an 8.9% loss on the 10-year Treasury.
In part, we are already starting to see the sort of generational losses in bonds that we should expect from the dynamics outlined above. To put a finer point on it, the Barclays Aggregate Bond Index is set for its first loss in 14 years, and only third loss since 1990. So, while gentleman may prefer bonds, they don't prefer losses.
The reality in markets is that there is rarely "One Thing" that dominates. Rising interest rates may prove to be the exception. This seismic "Queen Mary" shift in interest rates will certainly be one of the most critical factors over the coming quarters and years with wide-ranging reverberations. And, as money continues to flow from the bond market to avoid losses, equities will be awaiting with wide open arms.
Daryl Jones is Director of Research at Hedgeye. You can follow him on Twitter @HedgeyeDJ.
Young, educated workers were once seen by banks as the most promising borrowers. That's no longer the case, thanks to student loan debt.
FORTUNE – Graduation season is upon us. It used to be that in the years after hopeful twentysomethings bid farewell to campus life, they'd start borrowing to buy many things typically associated with adulthood -- namely, a car and a home. Many had college loans to repay, but MORENin-Hai Tseng, Writer - Apr 22, 2013 7:00 AM ET
Adults under 35 have more student loan debt and less exposure to credit card, car, and home loans. That's a troubling sign for the economy.
FORTUNE – Since the Great Recession, countless Americans have shunned the idea of taking on more debt. Homeowners discovered that stretching to buy bigger houses would result in years of financial turmoil. Jobless college grads unable to pay down their student loans now wonder if their degrees MORENin-Hai Tseng, Writer - Feb 25, 2013 10:57 AM ET
A mass mortgage refi solution is getting support from both sides of the political aisle. And it wouldn't cost taxpayers a dime.
FORTUNE -- Main Street taxpayers have bailed out Wall Street. Now it's time for Wall Street to return the favor by footing the bill to help millions of honorable Main Street borrowers pay lower interest rates on their mortgages, something that should have happened years ago. Wall Street giving MOREAllan Sloan, senior editor-at-large - Jan 18, 2012 5:00 AM ET
Brace yourself. Wall Street's latest advice to our deficit-addled government is to sell bonds that almost no one will live long enough to collect on.
If that isn't shocking enough, consider this: it's actually a pretty good idea, for the feds and the institutions that might be in the market for ultralong bonds.
The feds should consider issuing bonds that mature in 40, 50 and even 100 years, the Treasury Borrowing Advisory Committee MOREColin Barr - Feb 2, 2011 3:09 PM ET
|2 million Facebook, Gmail and Twitter passwords stolen in massive hack|
|Fresh fast food strikes planned for Thursday|
|Ron Paul: Bitcoin could 'destroy the dollar'|
|China's central bank bans some Bitcoin transactions|
|Top 10 U.S. cities for Chinese homebuyers|