The Most Important Number of the Week Is $10 Trillion

(Bloomberg Opinion) -- Market folks like to fancy themselves as amateur historians. It’s why you probably heard so much about something called the “Santa Claus rally” recently. The theory, first credited to Yale Hirsch of the Stock Trader’s Almanac in 1972, goes that a strong period for stocks during the end of one year bodes well for stocks in the new year. Who said the market was some mysterious entity that nobody understands?

Surprisingly, the Santa Claus rally has a pretty good track record. Since the mid-1990s, only six years did not end with a rally, and stocks finished the next January lower five of those six times, and the full year had a solid gain only once, in 2016, according to LPL Financial. So it should be good news that the benchmark S&P 500 Index surged 1.4% during the latest period. But, alas, stocks are poised for a horrible start to the year, dropping 1.68% in the first week of January through late Friday. That has implications for the “January Effect,” which says that the stock market’s performance during the first month sets the tone for the rest of the year.

So, while you rack your brain trying to figure out whether the Santa Claus rally or the January Effect will win out this year, consider this: $10.2 trillion. That’s the amount of bonds globally that have negative yields. What this means for the non-bond geeks is that instead of lending your money and having the borrower pay you interest, you’re effectively paying borrowers to use your money. Yes, that’s not normal; no one should willingly go into an investment that is guaranteed to lose money. The reason this number is important is because it speaks to perhaps the single-biggest reason stocks seemingly never go down anymore, or not for long if they do, and that is because there is no alternative.

This alone should support the stock market for some time even as the Federal Reserve and other important central banks begin to abandon their dovish ways. Granted, tighter monetary policy will be a big headwind, but consider that real, or inflation-adjusted, yields are deeply negative and will likely stay that way throughout the year even as the Fed raises its target for the federal funds rate. At around 1.75%, the yield on the benchmark 10-year Treasury note is about 5 percentage points below the rate of inflation as measured by the consumer price index. And even though economists and strategists surveyed by Bloomberg News see the rate of inflation moderating this year to 4.4%, that’s still higher than their forecast of 2.04% for the 10-year yield. That’s a big incentive to stay away from bonds.

What’s often lost in the debate over whether stocks will be able to withstand tighter monetary policy is the reason the Fed is tightening policy in the first place. Sure, inflation is elevated and policy makers want to get back to their target of around 2% before it does lasting damage to the economy. But the real reason, according to FHN Financial’s Chris Low, one of Wall Street’s most accurate economists, is that the economy and, more specifically, the labor market are so strong. The Fed is worried that a tight labor market will sustain inflation.

Even though the Fed is forecast to raise its target for the fed funds rate two to three times this year and start shrinking its balance sheet, the median estimate of economists surveyed by Bloomberg is for real gross domestic product to expand 3.9% in 2022. Besides last year, when real GDP likely expanded 5.6%, you’d have to go all the way back to 2010 to find the last time the economy grew as much. As a reminder, 2010 was a good year for stocks, with the S&P 500 gaining 12.8% after surging 23.5% the year before. While there’s no doubt that stocks are rich, with the S&P 500 trading at around 26 times earnings, stocks are always expensive — or cheap — for a reason. And one big reason is the outlook for earnings. The S&P 500 is expected to generate record profits per share of around $220 this year, up from an estimated $209 for 2021.

If there truly was genuine concern about equities and earnings power and an overly aggressive Fed inadvertently pushing the economy into recession, it would show up in the market for high-yield bonds. And yet the extra yield investors demand to own junk bonds rather than risk-free Treasuries is lower now than before the Fed’s hawkish pivot last month and lower than this time a year ago. That’s a sure sign that bond traders are confident that the outlook for corporate America is bright. The amount of bonds being evaluated for a ratings upgrade has swelled to $203 billion, the most since 2010, according to Bloomberg News.

This is not to say that stocks will come close to repeating their performance of last year, when the S&P 500 soared 26.9% to cap its best three-year run since dot-com bubble burst in 2000. There’s just too much working against equities. For one, the bears like to recall that the S&P 500 fell 6.24% in 2018 when the Fed raised rates while simultaneously shrinking its balance sheet. The sell-off, though, came in the fourth quarter and was due more to developments in China than anything having to do with the Fed.

We’ve just finished week one of 52 this year. Sure it was rough, but extrapolating a few days of bad performance for the whole year is something that even Santa Claus would overlook when checking his naughty and nice list.        

Fed Chair Jerome Powell did sendmarkets into a tizzy in October 2018 when he said that interest rates were probably "a long way from neutral," which traders took to mean that the central bank was poised to tighten monetary policy for much longer than forecast. Powell ended up walking back those comments in late Novemberand then raised rates just once more, in December 2018.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Robert Burgess is the executive editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.

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