Equity Market Highs, Bond Yields At Record Lows. Who’s Right? by Francis Gannon, The Royce Funds

With the post-Brexit environment in the U.S. presenting a classic disconnect between the equity and bond markets, Co-CIO Francis Gannon looks at what might be happening in the U.S. economy.

See the video here.

Equity Market Highs, Bond Yields at Record Lows. Who’s Right?

One of the things we’ve noticed in a post-Brexit environment in the United States is a classic disconnect between what the equity market is saying and what the bond market is saying.

And I think that is epitomized by the fact that the equity markets have digested Brexit and have now gone on to new highs, but yet, the bond market had hit new historic lows in terms of the yield on the tenure.

And the question is who’s right? And traditionally, people use the bond market as a way of predicting what might be happening in the overall economy, and to many people the bond market is predicting a recession is on the horizon.

The equity market is going on to new highs based upon the fact that earnings could be better than people think from an economic perspective.

Our work from a bottoms-up standpoint, which is what we do day in and day out, is meet with companies to try to understand their businesses, but you also get to piece together a real-time understanding of what might be happening in the general economy and United States.

And from a bottoms-up perspective, while the companies are not saying the economy is fantastic, they are saying that we are bumping along in what has been and continues to be a very anemic economic environment.

Equity Markets Are Not Predicting a Recession

The difference there is we’re seeing a bond market that is predicting recession and the companies are actually saying things are not that bad. And I think that’s what the equity market is showing you right now.

And there’s the opportunity in the market, at least from our perspective, especially for cyclical businesses within the small-cap space. Earnings are going to be key to that going forward.

Second quarter earnings are going to be a big part of that. And we’ll know more over the next several weeks in terms of what’s going to be happening from an earnings perspective.

Psychology Runs The Market In The Short Term

One of the classic kind of mantras of Wall Street is psychology runs the market in the short-term but earnings runs the market in the longer term. And earnings are key to the performance of the market, I believe, between now and the end of the year and over the next several years.

I think the surprise could be that earnings are better than people think, not as bad. Less bad than the market is perceiving right now, especially on the economically sensitive and cyclical areas of the overall market and the economy is better than people perceive, especially the bond market.

Bond Yields, Data Tantrum, Taper Tantrum

Bond Yields