Is Bond Market Cash Behind the Stock Market Bull?

Peter's Market Rap for the Week Ending November 24, 2023

Is Bond Market Cash Behind the Stock Market Bull?

Hi.  Peter Navarro here with this week’s market rap for the week ending November 24, 2023.

The US stock market took another quizzical leg up, with the S&P 500 rising 2.2% for the week and up a total of 7.6% for what has been described as a “red hot” November. 

This current rally has indeed defied the expectations of most stock market analysts, and the question remains, where does the market go from here?

In thinking about why the market has been moving up despite all the signs of a rapidly slowing economy, one possible explanation may be that of the dynamics of what is called “asset allocation.”

In the typical portfolio constructed by the typical advisor, an individual portfolio will feature some mix of stocks and bonds, for example, a 50-50 split.  And note here that the older one is, the more likely your advisor will recommend a split featuring a higher percentage of so-called “safer” bonds – a strategy which, by the way, has been a disaster over the last several years as these allegedly safe bonds have lost considerable value.  But that’s a story for another day.

In the meantime, this asset allocation construction is based on the observation that, at least in normal times, bond prices move inversely to stock prices so a “balanced portfolio” has a natural built in hedge.

Now, the most important thing to know about how asset allocation strategies can affect the stock market trend is that the bond market is HUGE compared to the stock market – a bond market ocean compared to stock market leg.

 Consider here that the value of the US bond market is about $51 trillion.  That’s more than 1,100 times the total capitalization of the US stock market.  That’s right, the bond market is 1,100 times bigger than the US stock market! 

Now, if we look at the big rally over the last month, it has come with what appears to be a significant drop in inflation and a corresponding fall in bond yields.  Equally important, the betting money is increasingly on a long pause in any further Fed rate hikes and the possibility now of more rapid rate cuts.  As a practical matter, this has made bonds relatively less attractive. 

And here’s the punch line: Even a small flow of cash moving out of a very large bond market can represent a relatively large flow of cash moving into a relatively small stock market.  So is a reallocation of cash from the bond market to the stock market on good inflation and Fed news really driving an upward move in a stock market which other fundamentals say should really be falling?  Let’s keep chewing on that for a while as we watch the action. 

From my perspective, I continue to believe that market is in a trading range, and we’ve simply bounced off a low and are now moving to a range bound high, with such movement having few legs left.  Cash remains king.

In the meantime, let’s see how the consumer performs on Black Friday as a harbinger of a resilient or retreating consumer.  Enjoy your weekend!