Could Bond Yields Break the Stock Market?

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1:17The next opportunity. The next investment. The next move. But sometimes what matters most is being ready for what you never saw coming. For more than 75 years, Cincinnati Insurance has worked with independent agents to help protect businesses, homes, valuables, and more. Because planning for the future isn't only about knowing what's next. It's about making sure you're ready for what you can't predict. Let Cincinnati insurance make your bad day better. Find an independent agent at CINFIN.com. Bloomberg Audio Studios. Podcasts. Radio. News. We're just like swinging between fear and greed every day based on the latest headline, you know.

2:02Where are we today? Mike plays fear. I play greed. Today we're fear. Yes. Today we're fear. Doesn't he look fearful? I'm Sarah Holder, and this is The Big Take from Bloomberg News. Today on the show, could the bond market break the stock market? And will the AI trade keep delivering? I sit down with Bloomberg Executive Editor David Papadopoulos and Managing Editor for Equities Mike Regan to pick apart the economic indicators we're seeing right now and where they're headed.

2:37Well, you know, one of the things we've seen of late is the real big spike up in bond yields across the globe. And definitely here in the U.S., in Treasury bond yields, they've gone quite a bit higher over the past month or so, which has got some people starting to worry that that could break the stock market. because if you can get higher returns, now north of 5 % on many U.S. Treasury bonds, well, heck, why do I need to take all the risk and buy stocks? Break the stock market. That doesn't sound good. I mean, I think that's a fair concern. Now, the only issue is, you know, every time you see that yield go up a little bit, if you own that bond, that means the value of your holding goes down a little bit.

3:23So I think what the market is doing right now is trying to figure out, all right, how high is this yield going to go? When is it sort of safe to jump in with two feet and start buying bonds? Yeah, and Tara, on that point, that last one's very important. The last five years for bondholders in the U.S., it's kind of been brutal. I mean, 2022 was a total wipeout. It was when the Fed suddenly said, holy smokes, we have a major inflation problem coming out of the pandemic. They started raising rates at a breakneck pace. And as Mike was saying, when rates are going up and bond yields are going up, the price of the bond collapses.

4:01So honestly, Sarah, from that period to now, if you just have held a 10-year treasury bond or a 30-year treasury bond, you're still down money because you took such a loss on the price side. So, yes, people are seeing those yields go higher and higher. And at some point they're saying, hey, I'm going to jump in and just take that 5 % yield or that 5.5 % yield. But I think some of them have indeed been a little bit spooked that is this the right moment to jump in or are they going to keep going higher? Anyway, when I say, you know, break the stock market, it's just this idea that are you getting to the point now where yields on bonds are so attractive that, hey, I don't want to worry about stocks and what could happen to the economy in a recession.

4:43I just want to put my money in a 10-year treasury bond, clip 5%, 5.5 % and take it to the bank. Is that happening, though? That is the typical way that things happen, right? People see higher yields on bonds. The stocks get less attractive. They reallocate. Is that what you're seeing right now? So, yeah, this is not a theoretical discussion right now. This is the discussion that's happening, I think, with financial advisors, with pension funds, with asset allocators. Is it time to sort of shift our ratio? We had a really interesting story out this morning looking at some research from Wells Fargo.

5:19And they pointed out that investors' allocation to equities is at 72%. And you assume, okay, the balance is mostly bonds. That's the highest, I think, since like 1969. It's the highest in a long time. Invested in equities than it's been in decades. You always hear that 60-40 ratio is sort of the ideal 60 % stocks, 40 % bonds. So actively on Wall Street, there are some strategists saying, advising their clients, time to sort of shift your allocation a little bit, a little bit more into the bond market, a little bit less into the stock market. You know, one other way to think about like this question of when is it right to move out of stocks and into bonds is the issue of like, I think the bond market, part of what's going on is the bond market is just simply catching up to the fact that the U.S.

6:07economy continues to grow at very high rates. Coming out of the pandemic, when the economy, given all that fiscal stimulus, all that monetary stimulus that was pumped into the system back then, the economy really is almost kind of never cooled off from that moment. You throw in the AI boom, which is a huge part of what's going on right now, and that's just sort of further added to it. So, like, I could get 5%, 5.5 % on a treasury, but you still actually, once you do the math of, among other things, you know, once I factor in inflation and then the taxes I have to pay, you're still actually, like, not doing great.

6:46This economy remains hot for sure, which is part of the reason why Kevin Warsh at the Fed and his colleagues raised interest rates a couple weeks ago now. But, yeah, so I think part of it is the bond markets is catching up to the fact like this is a hot economy. Lots of growth, lots of inflation. Yields need to go higher. Because I was going to ask, why are yields so high? It's a very basic question, but it could be about the hot economy. It could be about inflation. You're saying it's about both. Plus the fact that the U.S. government is running massive fiscal deficits, really sort of unprecedented in history, that at a time of economic well-being and a time of an expanding economy, no major crisis, that we're running deficits that measure around 6 % of GDP.

7:33It's the kind of number that you never see except in some sort of crisis time. That's also a huge factor. Massive deficits force the Treasury to sell lots and lots of bonds. So the supply of bonds goes up. And as the supply of bonds goes up, if demand is more or less the same for it, well, the yield has to go up. The price goes down, the yield goes up. Japan, Australia, and Germany are also seeing yields up. Why is that? What kinds of ripple effects could that have? I mean, I would say the forces you're seeing at play here in the U.S., the world's biggest economy, you know, coming out of the pandemic, that huge spike in inflation that never really quite came down, now coupled with the inflationary impacts of the war.

8:21So these are just phenomenon, or this is just a phenomenon, I would say, that just about the entire world is grappling with. And that's why you're seeing, you know, yields spike in those places. You know, all these countries are running large budget deficits, deficits that, again, spiked enormously during the pandemic. And very few countries brought them back down to normal levels. And so it is very much a global issue. I would say in many ways it's particularly acute here in the U.S. And how has Besson's strategy of buying up all these bonds worked? He's trying to bring down yields, right? Is that moving the needle?

8:59I think he's just tinkering around at the edges. I think he knows he has a major problem in trying to cap yields. I think that unless you get major fiscal reform of some kind or another, I think it's hard to turn that around. The last big factor, by the way, in terms of why yields are going higher is that AI boom again, because all these AI hyperscalers are also borrowing lots of money. They're issuing lots of bonds, further adding to that glut of supply. Well, David, you also talked about this idea on a call with some of our Bloomberg colleagues last week about how the value of the U.S. stock market is currently more than double the size of the entire U.S.

9:40economy. People like to call this ratio the value of the stock market compared to the U.S.'s annualized GDP the Buffett indicator. Mike, what does that ratio typically signal and how are you reading? Well, if I were to chat on Warren Buffett, I think he'd say it's no time to be greedy. I think he's viewing it as should you be greedy towards stocks or should you be fearful? And whatever it's at now, I think 240 % roughly is the highest it's ever been. He always thought, I think, 200 % was the danger zone. That said, over the years, he sort of softened his whole tone on this. For one thing, that ratio, it's not a mean reverting ratio.

10:25In other words, it doesn't tend to come back and average a certain amount over the lifetime of the data series. It's kind of trends higher and it has for a long time. And there's, you know, you'll see people explain it away as well. Well, the S &P is a lot more than just the U.S. economy now. There's this significant and growing percentage of revenue from overseas. And there's just sort of this structural reason why it would continue to expand. That said, it is kind of an alarming number to think the stock market's almost two and a half times the size of the economy. So certainly, you know, any hiccups in the stock market, I think, when it's that elevated would have a major ripple effect on the sort of main street economy as well.

11:08Does it mean a correction is coming? I wouldn't. And Buffett himself would say it's not a timing indicator. It's just another sign that, you know, the stock market is very, to put it nicely, very fully valued. Profit. Yeah, some may say overvalued. Now, I could give you the opposite side of that argument as well. Please do. Which is, you know, the earnings growth is just spectacular right now in the stock market. I mean, we're looking at for 2026, about a 29 % growth in S &P 500 earnings. That's, you know, amazing growth. Even for next year, it's looking like about 19%. If you go as far out as 2028, about 16%.

11:49Now, those numbers, the farther out you go, the more they tend to change. But, you know, so that's tremendous profit growth expected for the stock market. Of course, there's a big economic wildcard we haven't talked about yet. Any guesses? More from my conversation with David Papadopoulos and Mike Regan after the break.

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15:13I want to read some of these statistics because they really shocked me. You know, obviously we know that the Mag 7 stocks have been buoying the stock market for a while now. As of the end of August, Bloomberg reporting shows tech-heavy stocks making up more than half of the stock market. Goldman Sachs estimates that about 40 % of the S &P's total market value comes from AI infrastructure companies. What does that say to you? So a few things. You know, if you are in the camp that you believe this is AI is a bubble, which it very well could be, but you have to believe that those earnings I'm talking about is where the bubble lies, that, yes, the growth is 30 % this year, 20 % next year, but that's not sustainable.

15:55That eventually that growth will revert back to single digits. And I think that's really what the market is waiting for to see, you know, is this backlash, is all this concern about AI going to sort of affect the outlook for profits for next year and beyond? I guess what I would say about the AI boom, and does it ever pop at all? Is it a bubble that pops? I mean, I think financial historians will tell you that anytime you have this kind of innovation and economy of this scale, there's always froth and a mania that comes with it. And sooner or later, at some point, there is a bit of a bursting of the bubble.

16:36It could be painful in the short term, but it doesn't certainly doesn't need to be fatal. But is that does it happen in a day, a week, a month, a year, five years? I don't know. I'll just say there was a story that we ran today on how Rajiv Jain, kind of a big shot in the fund business, and who was a long AI skeptic and was super underweight AI stocks in all of his funds, just loaded up on AI stocks. That the pain for him just became too great to pay the price. And his funds were really, in recent months, underperforming the broader market. You could say, hey, I think this thing is a bit of a bubble that's going to pop at some point.

17:21But can you hold on to that conviction long enough before it forces you to capitulate? In the case of Rajiv Jain, it appears it's made him capitulate. Now, he says he's seen some things of late that have made him believe more in it, that it's here to stay. But I just thought that was sort of emblematic of that tussle that's going on right now. I want to ask about one more indicator that's coming from the bond market that is sometimes seen as a recession indicator. And I'm sorry to keep bringing us back to these warning signs, but I think they're important. The gap between the yield on 10-year and two-year treasuries is now the narrowest it's been since early 2025.

17:56That means the bond market is at risk of inverting, where longer-term bonds yield less than shorter-term ones. What does that say to you? Are you tracking that potential for inversion and how bad of a sign really is that? Yeah. So, you know, the sort of textbook analysis of that is that that type of inversion has been present before just about every recession we've had. Now, again, the timing is a little inexact. And Mike, I'll say, and many that we haven't had. Well, fair enough. Fair enough. So it doesn't always necessarily. Yeah. The last one being the big one. It's cried wolf before. I mean, we're also seeing record high diesel prices, high gas prices, mortgage rates just surpassed 7%.

18:42I'm wondering how these factors might put pressure on the stock market and not just on Wall Street, on Main Street. Just in general, rising diesel, rising fuel prices across the board and just, you know, it's part of that very stubborn inflation picture. I think it's got a lot to do with Trump's low approval ratings. I think it absolutely had an enormous amount to do with Biden's low approval ratings at the end. I mean, humans, this is something I learned very early on in my career living in South America. Humans do not like inflation. It affects everybody. And so the fact that it has remained as elevated as it has, and it's seemingly there's always something new spiking up at the grocery store or at the gas station or somewhere.

19:30I think it really has people at wit's end. You mentioned diesel, Sarah. Diesel's hugely important because unlike gasoline, you know, diesel kind of goes into the whole supply chain. You know, it's what powers the trucks and all sorts of stuff that bring us all our products and our food and everything else. So, you know, which again goes back to Kevin Warsh's bid to drive inflation down. And does he in the process sink the economy? And the White House has done a surprisingly well, good job of sort of convincing the market that this is all temporary, right? You know, since the war broke out, you know, six months ago, for better or worse, they've convinced the investing public that, you know, see through this.

20:19These diesel prices aren't going to stay here forever. You know, at some point, I think everyone sort of goes, wait a minute. We've been we've been hearing this for six months. You know, the consumer confidence numbers are some of the lowest they've ever been. Yeah. And yet we see the market up, you know, 13, 14 percent. It's, you know, clearly there is sort of a disconnect between the main street consumer economy and the rest of the economy. And I think that confidence number is largely just an inflation phenomenon. Yeah. Because you go to the grocery store, you can't afford eggs in the same way.

20:49Your wages aren't rising as much as inflation. That is the reality right now for the vast, vast bulk of Americans, that your pay is not going up as much as inflation is. And moreover, I would just say this. The magnitude of the inflation shock during the pandemic was so great that I think people are still trying to catch up to the sticker shock from back then. People still like, you know, they look at a bag of chips in the grocery store and it might be$8.99. And they're like, what? I still can't get over this price. Like, what happened? And maybe it's been at$8.99 for months and months and months now, but I've still got in my head that early 2020 level of$4.99 or whatever it was.

21:29And so I think, you know— And the feeling that wages have not kept up with inflation or with these gains in the stock market is not just a feeling. That's a fact. It is now true. There was definitely a period of time coming out of the pandemic where wage gains were quite robust. And for many people, not all, for many people, they were greater than inflation. Right now, you just look at, you know, macro data out of Washington. No, absolutely. The average pay hike is below inflation.

22:18It helps people find the show. Thanks for listening. We'll be back tomorrow.

22:32At Edward Jones, we believe rich is more than caring about the latest and greatest. It's also taking care of what gives your life meaning. That's why your dedicated financial advisor meets you where you are, with personalized financial strategies that help protect what matters so you can preserve your progress while creating a path forward. The key to being rich is knowing what counts. Let's find your rich together. Edward Jones, member SIPC. If you listen to financial news, you know a lot of time is spent thinking about what's next. The next opportunity, the next investment, the next move. But sometimes what matters most is being ready for what you never saw coming.

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