The Most Important Chart in the Bond Market

Jeffrey Buchbinder (00:00):

Hello everyone and welcome to LPL Market Signals, Jeff Buchbinder here with my friend and colleague Lawrence Gillum to talk a little about bonds. Before we talk bonds, Lawrence I want to share the, possibly the biggest accomplishment of my life. Yesterday morning, I got through the Atlanta Airport, TSA line in about 20 minutes. I bet you've never been more impressed with me than you are after hearing that. Here's a pro tip for all of you. Bring a kid through the line. You bring a kid through the line, you get kind of ushered through faster. I can't guarantee it, but that is certainly what happened to me and my daughter. So thrilled to lead off with that, Lawrence, I know you're playing a little bit hurt today. Hope you feel better beyond your little cold. How are you doing?

Lawrence Gillum (00:53):

I'm okay. It's pollen season here in the Carolinas and my lovely children decided to pass off their cold with me, so I'm fighting through it, but the show must go on, as they say.

Jeffrey Buchbinder (01:06):

I love the dedication and I guess there's probably some disappointed Duke fans there in the Carolinas today, but hey, they've had enough success, they'll get over it. So it is the last day of March. We're going to talk bonds. Of course. It's been a challenging month. I don't need to tell our listeners that. So we'll recap the market, which really is the same kind of recap that we've had the last couple of weeks, which is it's all about the conflict in the Middle East and high oil prices, which has bled into the rate market. Certainly, I guess the other piece of this today is going to be we'll just give a quick earnings preview earnings season starting here in a couple of weeks. And of course, it's quarter end, so the books are closed.

Jeffrey Buchbinder (01:58):

The market doesn't really care that much about earnings right now, but we do think it's a good reason why the S&P 500 is down about 8% from its recent highs. And not more so worth just reminding folks that the earnings foundation's strong. And then we'll close with the week ahead preview. And the jobs report is the big report of the week, which will come Friday, even though the markets are closed for the Good Friday holiday. All right, so starting with a quick market recap, I'm going to try to bring a little bit of good news here to these comments. First on the stock market. So, yeah, we are down 2.1% for the week, five straight weeks down. Clearly, there's not that much good news there unless you're an energy investor. There really hasn't been many gains to be found in the month of March.

Jeffrey Buchbinder (02:51):

But I think the ranking of performance since the conflict started actually is somewhat encouraging. You would expect consumer discretionary to be one of the worst performers. Because The oil price sensitivity, it is hung in there. Kind of middle of the pack you would expect tech because it's so market sensitive to be one of the weakest performers. It's held in there, okay kind of in line. So we haven't seen just a pure defensives, the winners and cyclicals the losers. So there's a little bit of sliver of good news. But generally speaking, over the last five days it was a sort of commodities up defenses outperforming cyclicals. You see the mega-cap tech stocks had a really challenging week, particularly Meta. So that weighed on Communication Services. And you see tech here, tech down 3.4% for the week, Communication Services down a little over seven.

Jeffrey Buchbinder (03:53):

So those were certainly huge drags. The defensives did hold it better over the last five trading days. This is the calendar five days. We're recording a little later Because I was traveling yesterday. It's Tuesday morning as we're recording this. But over the five days of last week, you did see consumer staples up a little over 1% for, you know, one of the few winners. And you saw real estate hanging there pretty well, despite the rate volatility down 0.7% that put all that together. And it was another week where value held up better than growth. And that has certainly been the case all year. You see value pretty close to flat year-to-date while the growth index, the top 200 is down almost 13. Put that together S&P down about seven year-to-date. The international markets have not held up as well lately because of the oil price sensitivity and the gains in the US dollar. But they continue to be better than the US year-to-date at the high level, the broad index level. So Lawrence turn to the bond market. I mean, the rates are coming down a little bit today, but you have had upward pressure here. It's oil prices. I mean, that's partly to blame what else is going on?

Lawrence Gillum (05:22):

Yeah, I mean, it had been a pretty challenging, or has been a pretty challenging month of March as well. The narrative has been primarily higher rates due to higher inflation expectations, particularly near-term, which we're going to unpack a little bit more in just a second with the most important chart in the fixed income markets right now. But the narrative has started to shift a little bit. We have seen some yields fall over the last couple days. But looking at performance over the past week this really does capture the, probably the, at least for now, the tail end of concerns about inflationary pressures yields higher bond prices. Lower Agg down about 10 basis points over the past week throughout the month of March, though we did completely eliminate the positive returns that we've seen prior to March.

Lawrence Gillum (06:08):

So now we're looking at negative returns for the year-to-date period for most of these fixed income markets. Agg down about 80 basis points on the year-to-date period. Mortgage is only down about 50 basis points, so slight relative outperformance but negative returns. Nonetheless. within that, the mortgage-backed sector, investment-grade corporates down 1.4%. We're going to look at spreads in just a second. Spreads have really hung in their pretty well over the past couple of months. We're starting to see a little bit of movement there. We'll talk more about that in just a second. But yeah, since the Iran conflict started, we've seen inflation expectations move significantly higher, particularly near-term inflation expectations. And that helped push the 10-year Treasury yield higher by about 50 basis points in a month. So it's been a pretty one-way direction of travel for rates. But over the last couple of trading sessions, we have seen that reverse a little bit. So it's starting to be a little bit of a narrative shift, which we'll talk about. But over the past month, it's been a pretty challenging fixed income market.

Jeffrey Buchbinder (07:13):

Yeah, for sure. This sort of rhymes with 2022 a little bit when stocks and bonds were struggling at the same time. So thanks for that. Lawrence. Here's, I changed the S&P 500 chart look here just to show you the drawdown. So through last Friday, we were down 9.1%, I'm sorry, through Monday down 9.1%. And then today we're rallying. So that drawdown percentage will come down a bit but still very close to a correction. And we're still, of course, as you can see here, below the not only the 50-day, but also the 200-day moving average. You know, historically, you do get a little bit weaker returns below the 200-day on a forward six and 12 month basis, but frankly not dramatically. So we still have experienced technical damage. Adam Turnquist has talked about that and written about it.

Jeffrey Buchbinder (08:05):

We want to see either a little more capitulation to suggest maybe the lows are in or we want to see an actual reversal and breaks back up through these former support levels that broke and have since become resistance. So that's what we'll be watching here going forward as we continue to follow the news flow. It's sometimes tough to use technicals when news, this is a headline-driven market. So we really want to see a pathway to ending this military operation before we're going to expect the technicals to be bullish. But we'll get there. It's just really testing investors' patience, testing all of our patience right now. So I threw this chart in. This is from a blog. It's on lpl.com that Adam did showing the returns by year against the max drawdowns during those years.

Jeffrey Buchbinder (09:02):

You've heard me talk about this before. You've seen different versions of this before. I'm sure for our regular listeners, it's a really powerful message though, so we keep coming back to it. On average, you're going to have a drawdown of about 14% in any given year. In up years it's about 11, and yet still the average return for the S&P is about 10. So, in other words, you're down 14 intra-year and up 10 anyway, right? What does that mean? Well, of course, we don't have a crystal ball, but it tells us that if we're down nine, even if we get on a little bit more, which is certainly possible, as the military operation continues, doesn't change our expectation that we're going to have a solid year for equities. That is what history tells us. So we think we're going to follow this playbook. Our forecast, when the year started was for high single-digit returns. We've not considered changing that. That puts you into the S&P 500 range of 7,300, 7,400. So I think that's a great message for all of you. And for those of you who are LPL advisors, certainly for your clients. So let's go to the fixed income Lawrence. So you're up again. We'll tease this. The most important chart in the bond market. We're not going to give it to you here, although the 10-year yield is important. We're still stuck in a range, huh?

Lawrence Gillum (10:27):

We are still stuck in a range. And despite all the volatility that we've seen recently, I think we've been in, you know, I think the treasury market has held up reasonably well given what's going on in the Middle East with the Iran conflict and the increase in oil prices. We've seen a big increase in treasury yields over the past month, as we talked about. But from a level perspective, we're not that far off from where we've been over the past year. So if you look at just the past year, we were from 3.94% up to 4.6% at four, at 4.34% we're kind of in that range. So despite these calls for a five handle on the 10-year Treasury yield, you know, it never really got close to that despite, again, the increase in oil prices that we've seen and the increase in inflation expectations that we've seen.

Lawrence Gillum (11:16):

What's been interesting though, and I'm sure you guys have talked a bit about this on previous episodes, but because of the increase in treasury yields over the past month, markets were starting to price in the chances of rate hikes which we thought was a bit overdone. That has been mostly removed now. It got so bad that markets were pricing in, you know, the potential for rate hikes into June of 2027. I thought that we were bordering on the absurd there for quite some time. But then after Friday's, I'm sorry, after yesterday's meeting with Jerome Powell and Harvard University there, he reiterated what he said after the Fed meeting, that they're in a wait and see mode, no rush to either cut rates or hike rates. So market pricing has moderated, and we've seen yields coming in a little bit because of that moderation. But I would say all in all, I think the treasury market has been relatively well contained from a level perspective, just given the increased volatility that we've seen out of the Middle East.

Jeffrey Buchbinder (12:19):

Yeah. And again, rates coming down a little bit today. If that continues, that's not only support for bonds, but also for stocks. Because remember, stock valuations are also tied to interest rates. So in fact, we said at the start of the year, the 10-year yield was probably the most important thing to watch in markets. The biggest determining factor in what happens for stocks and bonds in 2026. All right, so next up is spreads. What do you see here, Lawrence? Yep.

Lawrence Gillum (12:48):

These are curve spreads. This is the difference between the 2-year Treasury yield and the 10-year Treasury yield. This, I think, has caught a lot of people off guard. Coming into the year, us included, we thought that the treasury yield curve would continue to steepen. So we thought we'd see a bigger difference between the 2-year Treasury yield and the 10-year Treasury yield. That really hasn't happened. We've seen that the treasury yield curve flatten, and we're down to around 50 basis points from over 70 basis points earlier this year. It's one of those things that we talk about internally about reasons why we don't necessarily want to extend duration or add interest rate sensitivity to portfolios right now, just because you're not getting compensated for it as the difference between the 2-year Treasury yield and the 10-year Treasury yield has really collapsed. You're only getting about 50 basis points of additional compensation to own these longer maturity securities. But with five times the additional volatility. So the takeaway from this chart is that we remain neutral duration, neutral interest rate sensitivity versus our indexes. And until this reverses and gets back into a steeper we're probably going to keep that positioning on again, just because you're not getting compensated to take on that additional rate risk right now.

Jeffrey Buchbinder (14:01):

That makes a lot of sense. So how about rate volatility here? This is kind of like the VIX for treasury yields, right?

Lawrence Gillum (14:10):

That's exactly right. So this is the implied interest rate volatility for the, for the treasury market. And we have seen a tremendous increase in volatility or a tremendous increase in implied volatility this year, which is important again, to consider that again, one of the reasons why we haven't really done anything in terms of adding risk to fixed income portfolios, whether it's credit risk or interest rate risk, is because we were in this really low implied volatility regime that does tend to remedy itself over time. And you can see these big increases in volatility that we've seen here recently. And a lot of times people that try to you know, reassess their portfolios at these very low volatility regimes or during these very low volatility regimes, you can get caught off sides.

Lawrence Gillum (15:01):

So another thing that we take into consideration internally is the rate volatility environment. And when rate volatility is really, really low, you don't want to make a lot of bets because it can reverse itself pretty quickly. That's what we've seen. So now there are a little bit more attractive opportunities within the credit markets in particular, which we'll talk about. But this has been one of those areas that we've been waiting to see just given that low volatility environment that we're in this is an area that we think that we can add a little bit of risk to portfolios and take advantage of kind of this risk off environment, if you will, that we've seen here recently.

Jeffrey Buchbinder (15:42):

Yeah, generally we like buying equities when the VIX is in mid to high thirties or 40, I think you can say the same thing here. You certainly did well you know, buying bonds coming out of these prior rate spikes, I guess we call EM rate vol spikes, which certainly coincided with fears of rising rates and move higher in rates. So yeah, we've been watching the oil VIX most weeks, and it's kind of a similar story. Once we see these things cool off you're certainly making more progress toward putting in a durable low and that it probably coincides with us being more interested in buying here. That's right. So the teased favorite chart in fixed income there's a lot of lines here. I know you'll boil this down into a simple message, but looks like it's around breakevens, that is the chart of the week.

Lawrence Gillum (16:40):

Yeah, I'm still seeing the rate bullet. There we go. A little lag on my end, so apologize about that. So yes, I've been saying this is the most important chart in fixed income right now for a couple different reasons. And what all these squiggly lines represent are the market implied inflation expectations by TIPS breakevens. So even simpler, if you think about the difference between a treasury and inflation-protected security, TIPS, and a nominal treasury security, that difference in yield represents the market's implied inflation expectations. And there are really two takeaways here that I think are very important to point out, is that if you look at these short-term inflation expectations, that's the dark blue line as well as the kind of the orange-ish line, you've seen those move higher particularly for that dark blue line, the 2-year breakeven markets are pricing in the expected inflation rate of around 3.3% over the next two years.

Lawrence Gillum (17:38):

Over the next five years, markets are saying inflation will be around 2.63% on average, over that five-year period. So markets are pricing in a near-term inflation shock, but after that, they're kind of looking through this near-term inflationary shock and saying that there's a potential for a disinflationary environment on the back end of this episode or this environment. And that's really kind of coming through with that light blue line this is what's called a 5-year, 5-year forward. So this is the market's expectations for inflation from 2031 to 2036, so not the next five years, but the five years after that. So 2031 to 2036 markets are saying that inflation's going to be below the Fed's target which is interesting. So the longer-term narrative is kind of switching from near-term inflation shock to near- to longer-term growth shock.

Lawrence Gillum (18:36):

Now you know, this is a pretty volatile index, so you could, we could see this reverse, but I guess the takeaway and why this is the most important chart in fixed income right now is that the markets are saying this near-term inflation shock is just a near-term thing. It can't use the word transitory, but it's a temporary thing, and not a longer concern vis-a-vis stagflation. So I think that the markets, or we think the markets are probably right here. And despite the increase in oil prices, that this is a near-term kind of inflation event, not something that's going to be structural in nature that would cause the bond market to sell off even more than it has in recent periods.

Jeffrey Buchbinder (19:24):

Yeah, even if there's more of a geopolitical risk premium built into oil prices, and maybe the floor is 50, maybe it's 70, as long as we stay there and we get some more disinflation from the rest of the economy, which we were getting just been interrupted, but we go back to that environment of disinflation less core services inflation I think you'll you know, you'll see markets respond and, you know,, these breakevens will look even better. So good stuff there. Lawrence, I guess that echoes what Fed Chair Powell was saying about kinda looking through this, which appears to be what the market's doing. I mean, the stock market would be down more than 8% from its high if the market was not looking through this and pricing in a 1970s stagflation environment. This is nothing like the 1970s. Primary reason, of course, is because we're energy independent. Keep that in mind. Very, very important. And this is why President Trump's been comfortable saying that we don't need the Strait of Hormuz. It's really not that important. And even suggesting that we could just walk away and leave it, I don't necessarily think that'll happen. But energy independence is of course key there, which is why we're not going to have a repeat of the seventies. So

Lawrence Gillum (20:48):

Although I will say the music.

Jeffrey Buchbinder (20:49):

Last chart, credit spreads.

Lawrence Gillum (20:50):

The music and the fashion were better in the seventies. I think that goes without debate.

Jeffrey Buchbinder (20:57):

Oh, absolutely. No doubt. I think everybody listening agrees with that. So let's wrap up the bond section with credit spreads here, Lawrence. I mean, we're not rooting for credit spreads to widen, but we certainly expected them to, and now we're seeing it. Yes.

Lawrence Gillum (21:15):

For sure. And I mean, we've been talking about the complacency out of the credit markets for quite some time now. In our 2026 outlook piece that we released back in, I think it was in October and November, we talked about the potential for spreads to widen. And that's what we're seeing. So it has been a pretty orderly increase, or widening, in spreads. We haven't seen spreads gap out. And so there's not an overriding concern out of the corporate credit markets, but it is adding value back into those corporate credit markets. So the blue line represents the high yield spreads, which, as a reminder, just represent the additional compensation to own riskier debt versus treasury securities. 3 31 is still on the low end but we're seeing an improvement there. We would start to get, you know, interested around 4%, 425, 450

Lawrence Gillum (22:07):

So directionally we're headed in the right way in terms of potential to add risk in our portfolios. Again, we're not there yet. But if you look at the high-grade index, the orange line still only around 89 basis points over treasury securities, less interesting in that market, we think that there's still some potential for increased spreads in that market particularly given all the AI issuance that we're going to start to see this year and into next year. But the high yield market is starting to look a little bit more attractive than it was certainly to start this year when we were, you know, at kind of secular tights in terms of spreads representing just very little compensation to own risk versus treasury securities. We've seen that widen a little bit, which is, which is making this market a little bit more interesting.

Jeffrey Buchbinder (22:53):

Yeah, kudos to you for that advice, you know, late last year, keep your fixed income portfolios high quality, you said we wrote, and you know, use it as defensive cushion, decent yields and some cushion against equity market volatility that has absolutely been the right call and has certainly, you know, benefited the portfolios we manage and our clients who follow our advice. So thanks for that Lawrence. Really good stuff. Fixed income kinda like equities, we're just waiting for a path to calm. We think it'll come, probably come pretty soon, don't know exactly what it looks like, but we're ready for it. And certainly have our fingers closer to the buy button than the sell button. All right, let's go to earnings. This is the weekly market commentary for this week on lpl.com double-digit earnings growth streak, likely to continue in Q1.

Jeffrey Buchbinder (23:51):

That'll be six straight quarters, which is really amazing of double-digit earnings growth. But then we pose the question, will anyone care? Because of course, it's all about oil and the Middle East. But nonetheless as I alluded to earlier, no doubt, the Earnings Foundation and the Economic Growth Foundation, by the way, are providing strong support for stocks. This conflict, the stock market would be down more if we did not have this. Now you can point to 1990 as an example, right, where the market reacted much more negatively to the start of the first Gulf War. The economy was fragile already and you didn't have that support, right? Well, now we have it looks a little bit more like 2003, the start of the first or the start of the Iraq War where the economy had already healed from the dot-com bust and the accounting scandals of 2002.

Jeffrey Buchbinder (24:52):

We were on an upswing market, was just better able to handle that. And, you know, that was the launch of the five-year bull market that went through into 2007. So looks a little more, bit more like that to us than it looks like 1990 or the seventies, as I mentioned. So here's your earnings growth trajectory. We grew earnings in fourth quarter, 13 plus percent. I think we're going to do better than that this quarter. Probably looking at 15, 16% for Q1 when all the results are in. And then this double-digit earnings streaks probably going to continue.

Jeffrey Buchbinder (25:36):

Earnings estimates have been going up, which I think is probably surprising to many. It's even surprising to me. And I filed this stuff really closely that has pushed the S&P 500 valuations down to around 19. The forward price-to-earnings ratio on the S&P 500 is now 19. If we get a little more downside. And you're talking about a P/E of 18, that's right in line with the long-term average. So all those folks that have been talking about how expensive stocks are or have been in recent years, you know, that's no longer a bear case. I would argue it's not a bear case now, but it certainly wouldn't be if we go down another 5% or so. So this is a really unique environment where you got really strong earnings and they've just been, not only not affected by the Middle East and higher oil prices, but they've actually gone up in spite of what's going on in the Middle East.

Jeffrey Buchbinder (26:36):

You not just seeing energy sector earnings go up, you've seen really broad earnings expectations go up. Now, we still will have cautious guidance because of course, I mean, you've heard it, for example, United Airlines I think talked about potential $175 oil, and they were planning around that. There are a number of examples of that if you have to account for the risks. So guidance is going to be a little cautious. Estimates are probably going to come down. In fact, this next chart showing operating margins is a nice tie-in here. Margin expectations are probably too high, right? And so as companies guide to potentially factor in higher interest rates, fewer Fed rate cuts, and higher oil prices, you're probably going to see margins come down and estimates for S&P 500 profits come down, right? Look at this. I mean, the expectations, I should have put these numbers in here.

Jeffrey Buchbinder (27:35):

They're just, the expectations for margin expansion are through the roof. Hopefully we get it. Certainly AI productivity boosts will help, but this just looks too optimistic to me. But it does tell me that we're probably going to get margin expansion for the next several quarters. We've got margin expansion for the last several quarters. Again, strong support. So we're pretty optimistic we're going to have a good earnings season. We've got fiscal stimulus, we've got AI investment and companies continue to do a really good job managing costs. You have a corporate America that's pretty insulated from what's going on in the Middle East, so energy independence, working force. So that's just a little bit of a preview of earnings. Check out a weekly market commentary if you want more. The week ahead Lawrence is pretty straightforward. It's, we're going to be on a holiday on Friday and we get the jobs report. I think that's probably the biggest report of the week. Although if there's anything else going on that you think is worth noting, let me know.

Lawrence Gillum (28:40):

Yep. No, it is about jobs. We got JOLTS data today. A little, a little delay, but came in as expected. We got non-farm payrolls on Friday. I will not be paying attention to the, to that release, at least not when it's initially released. I'll, you know, check it later in the day. Because We do have the day off. Importantly from a fixed income perspective, no treasury auctions this week, last week, treasury auctions by, I think most accounts were pretty bad. So the market doesn't have to worry about that this week. There was some Fed speak. We got, as I mentioned, we had our Fed Chair Jerome Powell talk yesterday provided some, you know, calming message to the fixed income markets, really. But as it relates to the economic data, non-farm payrolls and I think we got retail sales this week too.

Jeffrey Buchbinder (29:31):

Yeah, it's on here Wednesday. Okay.

Lawrence Gillum (29:33):

So those are really the big items that matter. Other than that I don't want to say relatively quiet, but hopefully it's just not a big economic surprise week. Because That's going to make our chief economist Jeffrey Roach even busier than he is.

Jeffrey Buchbinder (29:51):

Yeah. And that's no joke. April 1st is retail sales day. We're going to get that. And happy birthday to my mom. So it's real. Again, it's just like the last few weeks. We're all going to watch what's going on in the Middle East and in particular, the Strait of Hormuz. Hopefully there's a diplomatic path to get to a better place and relative calm. But we're just, we're not there yet. And a hundred dollars oil tells you that we are not there yet. So we won't talk about earnings you know, earnings preview specifically in terms of the week ahead until next week. But then we're going to start talking about the banks. So I think with that, we'll go ahead and wrap. Thanks again, Lawrence for Playing Hurt. Really good stuff on the bond market, again, with the market commentary on earnings season.

Jeffrey Buchbinder (30:47):

By the way, Adam Turnquist added a section on his technical analysis take. So really, really good stuff. So check that out. You know, kind of assessing the technical damage that's been done here. And then Lawrence, you highlight, you've got the rate and credit view out there on social media, on private credit. And then Adam also did a blog about his outlook for the S&P 500 from a technical perspective. So check all of that out on lpl.com. So feel better, Lawrence, everybody out there. Hopefully you feel good. Have a wonderful week. Take care and we'll see you next time on LPL Market Signals. Thanks for listening.