US shares vs Government bonds

Source: Federal Reserve St Louis.

Wall Street has fallen -4% over the past week. This was off the back of record highs on January 26 with the S&P 500 Index peaking at 2872.87 (black line).

What’s behind the share correction? Well the “bears” would argue that US shares were already overvalued on key measures. There was also evidence of ‘irrational exuberance’. Positive investor surveys, high margin debt and the very low VIX volatility readings all indicated elevated levels of optimism.

Yet the primary catalyst for a share correction has been evident for the past six months. The US Government 2 year bond yield has surged from 1.3% to 2.1% currently (red line). Bond markets are increasingly nervous that US inflation pressures are starting to build as wages have risen and the US dollar has weakened. Given there is a new Fed Chair and committee members in 2018, the Fed could easily shock financial markets with a more aggressive interest rate stance. The days of cheap money in terms of low bond yields seemed to be over six months ago. So after Wall Street’s dream run with record highs, US shares seem to have finally awoken to the reality of higher bond yields.

 

Source: nab asset management 5 February 2018

Author: Bob Cunneen, Senior Economist and Portfolio Specialist

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