The Fed-Fueled Rallies in Stocks, Bonds and Gold
Featuring Chris Verrone
Published on: June 26th, 2019 • Duration: 14 minutesChris Verrone, partner at Strategas, returns to Real Vision to discuss the Fed-induced liquidity rally that’s driving the action in stocks, bonds and gold. He analyzes the trends using technical indicators, notes historical examples to pay attention to, and provides his outlook for the three markets, in this interview with Justine Underhill. Filmed on June 25, 2019.
JUSTINE UNDERHILL: Welcome to Real Vision's Trade Ideas. Today, we're sitting down with Chris Verrone, a partner at Strategas. Great to have you back.
CHRIS VERRONE: Great to be here.
JUSTINE UNDERHILL: So, there's a lot of stuff going on in the markets after the Fed had a little bit of a dovish pivot last week. We saw gold, stocks, bond all rally. Could you take us through what you see going on here and why they're all trading in sync?
CHRIS VERRONE: Well, let's first talk about how unusual it is historically to have gold, stocks and bonds all making new highs at the same time. We went back really 40 or 50 years, that's only happened one other time in history where all those were firing at the same time. I think it's speak to the idea, this is still a very liquidity driven market. And liquidity indicators or liquidity barometers are going to be our best tell for when something is changing. I think when you look at that backdrop here, we do continue to like stocks, I recognize we're back up into the levels that we fail that for the better part of the last 18 months. But I think there's a couple key differences this time around.
It's a number one, the new high data is expanding. So, participation in this move has actually been better than we've seen over the last year. And secondly, speaking of liquidity, a lot of the liquidity indicators are reaccelerating. Money growth, as an example has turned back up. So, we like the backdrop for equities. We'll see what it means for the other two. But I think generally, we're okay here.
JUSTINE UNDERHILL: And in terms of the last time this happened- when all three were moving in sync, were there any abnormalities in the market or is there anything that you could relate to today?
CHRIS VERRONE: Yeah, it was another easy money QE period, it was summer of 2016. You had bond yields at 132 10 Year Yields, you had gold just starting to base and starting to turn up. So, I think maybe the message here and this is maybe the difference from the last 12 months, we're back in this environment where liquidity is easy. Central banks are easier than they have been in some time. And I think it creates a bid for risk assets. I think, again, the important picture for us is money growth reaccelerating means there's more excess liquidity out there to flow into risk assets. I think we're still very much in the same environment that we've been in for the last number of years.
JUSTINE UNDERHILL: But it's funny, because you're talking about risk assets, but then in some ways, going into bonds and gold is a little bit risk off in a way.
CHRIS VERRONE: Yeah. I think it's reflective of when there's excess liquidity, everything goes up. And historically, it's not a very, very frequent occurrence or very common background, I guess you go back to the 19-, late 1940s, late 1950s as maybe another period where we saw bond yields at similar levels and stocks also working. But it's been historically rare, and there's no question about that.
What's maybe more interesting is what is gold trying to tell us though about the future? Is it inflationary? Is it deflationary? I don't think we know the answer to that yet. But what I think we can say is, after six or seven years of total indifference, of really a pretty devastating bear market in gold, something they're starting to change, and that has our attention.
JUSTINE UNDERHILL: Do you think it could be on the one hand that the stock market is looking at a three to six-month range where it's like, oh, yeah, easy money? And then on the other hand, you have the bond market and gold looking at maybe a six to 18-month range?
CHRIS VERRONE: I think that may be more evident than gold, the message that at some point, there will be a bill that's due for all the easy money that's out there. I also find it compelling that when you look at gold historically, it has worked both in deflationary and inflationary environments, gold worked in the '30s. It also worked in the '70s. So, I'm not yet sure whether the conclusion is there's more deflationary trends in front of us or maybe gold is starting to price in a change in inflationary pressures moving forward.
But as someone who looks at pictures and charts, I don't particularly care what the reason is, I want to own it. This is a major trend change in gold. Tactically, it's probably overdone. We've seen some very aggressive flows the last couple days, but I would use pullbacks opportunistically I think this is the start of a change in gold for the first time in 20 plus years. It really resembles that late '98-'99 period where gold started to bottom.
JUSTINE UNDERHILL: Yeah, actually, so gold right now has broken out of a five-year base.
CHRIS VERRONE: More, yeah.
JUSTINE UNDERHILL: Yeah. So, over the long run, let's say, actually, let's say through the end of the year, where do you see that potentially going?
CHRIS VERRONE: I think in the near term, next several months, you're going to get a consolidation phase here. And I would not shock when you see gold actually trade back down to that $1325, $1350 range. Looking out longer term, $1750, $1800. Maybe a run back at the old highs I think over the next number of years, is where gold likely trades. This breakout to us is very reminiscent of what we saw in the late '90s, early 2000s, where after really a decade plus of underperformance, gold started to begin to work. I think we're in that early phase here.
JUSTINE UNDERHILL: And to equities, where do you see that going, specifically with the S&P 500?
CHRIS VERRONE: It's funny, we're always asked in our business, what the price target is, and I find targets to be a little silly. I think it's hard enough to get direction. So, the direction in our view, or the trend, as technicians will call it, is still up. I think the trend in stocks is still up. We basically have spent the last 18 months in a 2300 to call it 2900 range, a simple projection from that breakout will get you somewhere on the magnitude maybe 33 to $3500. I think that's a fair range over the next 12 months.
Now, one of the push backs you could certainly offer as well, S&P's at new highs but small caps are not.
JUSTINE UNDERHILL: Right. So, the Russell 2000.
CHRIS VERRONE: Sure. And Russell 2's about 10% below prior highs. And intuitively, that sounds negative, it sounds bearish. It's actually historically not as significant as people would suspect. We've seen that three times in history where the S&P's at a new high and small caps are at least 10% below a new high- 1985, 1991 and 1998. And all three of those instances, small caps ultimately caught up and made new highs of their own. So, I think we need to be careful extrapolating too much beyond this divergence between small caps and large caps. I think ultimately, the market's probably okay here.
JUSTINE UNDERHILL: What other indicators are you looking at for the S&P 500 to see that rally?
CHRIS VERRONE: Yeah. I think the knock on this market over the better part of the last 18 months was that participation had been pretty narrow and had been a certain type of stock like a Fang or large cap tech that had been driving the whole move. I think it's important participation runs out beyond just that. Last week, we had about 50% of the S&P make a one-month high.
It's a good indication that at least tactically, you're starting to see more stocks participate in this move. We've seen some improvement on consumer discretionary, particularly restaurants, hotels. We've seen some improvement in biotech for the first time in a while. So, some groups that have been neglected over the better part of the last year start to get back into the fold. We like that. The more stocks, the better, that are participating in this.
And it speaks to this idea and you'll hear very often, oh, it's bearish or negative that REITs and utilities and staples are going up. I disagree entirely. It's hard for me to look at anything going up and say that's bearish. It's bullish if you own those groups. And I think the leadership we've seen from some of those bond proxies or rate sensitive groups very much speaks to the idea that this is an environment where there's still a reach for yield. And as long as 10 Year Yields trade 2%, you're going to have people reaching into the equity market to find bond-like return through bond-like yields. So, I still think it's a very dominant thesis here.
JUSTINE UNDERHILL: Okay. And speaking of bond-like returns and bond-like yields, where do you see the bond market going, specifically, the 10 Year Treasury?
CHRIS VERRONE: It's anyone's guess, and I think anyone who's told you they're looking for higher yields, which is basically been everyone over the last decade has been wrong. So, I want to preface that very humbly. I think at the end of the day, there were some signs or there have been some signs over the last few weeks of a blow-off in bond yields here. I think it's notable that despite 10 Year Yields back to 2%, you haven't seen things like copper make a new low, you haven't seen emerging markets take another leg lower.
So, there are some I'd say leading indicators, even global economic surprises have started to turn up here, some things we would look to for some forward information where bond yields go haven't confirmed this last leg lower in yield. So, it wouldn't shock me to at least see bond yields start to stabilize somewhere in this 2% range now. Let's remember, bond yields were 132 in summer of 2016. And they traded to 330 in the fall of 2018, we've given back about 125 points of that move. So, we've already seen half of the move go away. It's a pretty good correction over a relatively robust period of time. I suspect we're getting close to some interim low in bond yields here.
JUSTINE UNDERHILL: What do you see as the biggest overall risk to the stock market going up and the bond market continuing to climb and gold climbing?
CHRIS VERRONE: It's probably something we're not thinking about, as it always is. And we've been saying in our client meetings, it just strikes me how often people want to talk about what they perceive to be the same risk, whether it's US- China trade or Washington or Brexit, these very well-known things, I doubt it's any of those. It's something we're not thinking about.
And there's a really good index, it's called the Policy Uncertainty Index. It basically measures how much "uncertainty" is out there. It actually works the opposite you would expect. When it spikes, when you're at peak uncertainty, it's actually been consistent with stronger than average forward market returns. When everyone is uncertain or uncomfortable, actually want to be buying stocks, that index actually spike pretty sharply over the last couple days into the 99th percentile of all observations. So, when you get those big spikes in stress or uncertainty, it's actually a good time to be buying stock.
So, I think the contrarian view here is trying to move away from all the noise in things that are unforecastable. China trade is unforecastable, Brexit's probably unforecastable. And instead, just focus on the message of the market. Take for instance, some of the emerging markets, US and China's where everyone's focuses yet Brazil's at new highs, India's at new highs, Russia's at new highs, Australia X, well. There's some really good things going on around the world that have not gotten the attention that they probably deserved, because of a very myopic focus on something that we can't forecast. And that seems like a waste time to us.
JUSTINE UNDERHILL: Do you think that earnings season could hold up? Especially when looking at comps from this year to last year, do you think that that's might be a weak point?
CHRIS VERRONE: So, I can't speak to what the numbers will look like. That's outside of how I look at the world. But I would say it does seem to be a very consensus view to be worried about earnings in the second half of the year. And it just has always struck me, we're basically in the business of human behavior. And there does seem to be a growing consensus that because of things like tariffs or trade or weaker data, second half earnings will be weaker than the consensus expects, that seems to be a well-known story. So, I might be inclined to position on the other side.
JUSTINE UNDERHILL: All right. Can you summarize your view on stocks, bonds and gold in 30 seconds?
CHRIS VERRONE: Yeah. I think the trends in stocks is up. We spent the last 18 months in a range participation broadening out, we welcome that. Bonds, I think we're in the ballpark of some type of a blow-off in yields. I'd be surprised to see 10 Year Yields much lower from here. Gold, I think is the start of a major trend change. It's been basing for the last five or six years. Good breakout above $1400. Tactically, use weakness here opportunistically. $1325, $1350 will hold as support, longer term, we'd like it to challenge to the old highs over the next couple years.
JUSTINE UNDERHILL: Great, Chris, thank you so much.
CHRIS VERRONE: Thank you.
JUSTINE UNDERHILL: So, Chris is bullish on equities. Specifically, he sees potential for the S&P 500 to reach a range of $3300 to $3500 over the next 12 months. Additionally, he sees bond yields consolidating around 2% and he believes gold is in the midst of a major breakout. He recommends buying on weakness and see strong support in the $1325 to $1350 range with upside potential of $1750 over the next 12 months.
Just remember this is a trade idea and not investment advice. You should do your own research, consider your risk tolerance and invest accordingly. For Real Vision, I'm Justine Underhill.