Is the time for bonds over?, Inflation in the USA at new highs

Chart of the week

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The chart shows when the returns on equities and bonds both moved in the same direction, i.e. both made a profit or both made a loss (blue area). In the red area, the returns of the two asset classes behave differently.  

Why that is important

Over the past 20 years, equities and bonds have complemented each other well, and the combination of the two asset classes has reduced the risk or volatility of a portfolio. When stocks have fallen in price, bonds have risen. So it was a perfect combination.

Since the beginning of the year, this has changed. Both stocks and bonds have lost value. Many investors are surprised by this, because this is the first time in their investment career. However, if you look further into the past, this happens more often than the behavior we have seen over the last 20 years.

It is likely that bonds will continue to fluctuate in the same direction as stocks over the next few years, and the golden last 20 years will not return. However, since bonds fluctuate less than stocks, they will continue to minimize the risk of a portfolio, but much less than in the last 20 years.

In addition, the fluctuations in value in a portfolio will generally increase.

Inflation in the USA at new highs

The new inflation figures for June in the U.S.A. once again reach new highs of 9.1%. A value of 8.8% had been expected. The inflation slowdown expected by many did not materialize.

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The chart does not show the annual inflation as usual, but the monthly change. This is helpful to see from which areas the inflation comes. Most of the high inflation continues to come from the energy sector. However, of concern is that steadily rising prices are now coming from other areas as well. These are rent and housing costs (rent and OER), car prices and basic medical care. There is a growing danger that inflation will become stubbornly entrenched.

The current annual changes can be read here.

The chart shows how strongly inflation is normally driven by energy prices. From 2000 to 2020, inflation can be almost entirely explained by the change in the price of oil. The black line and the blue line have an almost identical course. In that year, this has now changed completely. Inflation has now spread to many other areas of daily life.

The Federal Reserve in the U.S. is now forced to be much more aggressive in fighting inflation.

The chart shows how strongly the probability of a one percent interest rate hike by the U.S. Federal Reserve has increased following the announcement of the latest inflation figures. It now stands at over 90%.

The only area that is currently giving the all-clear is that global supply chains are returning to normal.

The chart shows an index developed by Goldman Sachs (green dotted line) that shows how badly supply chains are out of kilter and what effect this is having on prices. It is expected that supply chains will return to normal in the coming months and that the pressure for higher prices will ease.‍

Recession probably inevitable‍

Until now, the U.S. Federal Reserve has always tried to raise interest rates only to the extent that no recession would follow. Because inflation remains high, it can no longer take this into account.

The chart shows the difference between the interest rate for 10-year and one-year government bonds in the USA. For a bond that lasts 1 year, you currently get a higher interest rate than for a bond that lasts 10 years. This is very unusual and is called an inverse yield curve. An inverse yield curve is one of the most reliable indicators of a recession. The majority of investors now believe that the U.S. will force the economy into recession with further aggressive rate hikes.‍

USD continues to rise

We have often argued in the blogs that the USD should now weaken against the EUR. The main justification was that with the now beginning interest rate hikes in Europe, the interest rate differential is decreasing and thus investment money flows back from the US to Europe.

With the announcement of the current inflation figures in the U.S. and the U.S. Federal Reserve now forced to continue aggressively raising interest rates, this trend reversal is shifting. The interest rate differential between Europe and the USA is now likely to increase.

The chart shows the annual change in the USD index since 1988. Even if the USD continues to rise, we are historically close to a turning point. It is not possible to say exactly when the USD will weaken again, but the air for a further rise is becoming thinner and thinner.

The chart shows the foreign trade deficit of Germany. The strongest economy in Europe. The weak state of the German economy raises concerns and puts the EUR under pressure. Another reason for the currently higher USD.‍

Start of the earnings season for the 2nd quarter

This week the earnings season for the second quarter has started. As usual, this begins with the announcement of the profit results of the banks. The figures were within the expected range, some could even convince positively.

The chart shows in yellow the performance of the S&P 500 Index and in blue the number of analysts' earnings estimates that are raised or lowered. Ahead of the second quarter earnings announcement, a majority of analysts lowered earnings expectations for all companies in the S&P 500 Index. This is another reason why the stock market has been so poor in recent weeks.

However, it now appears that expectations are so low that companies may surprise on the upside rather than the downside. ‍

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