Something unusual is happening in financial markets. Bonds are pricing in a recession, while the stock market and other economic indicators are forecasting a boom. How this divergence resolves will be the driving force in terms of defining 2020 and could even decide the presidential election.
One perspective is that the move in bonds is a flight to safety trade given the uncertainty of the coronavirus and its economic impact. In that sense, it's similar to what happened following Brexit in June 2016 and during the European sovereign debt crisis in 2012. In July 2012, the 10-year note hit a low of 1.39%. In June 2016, it reached a low of 1.37% before turning around.
Comparing and contrasting these events to the current one increases confidence that this is not the time to be buying bonds, and it could present a remarkable opportunity to buy commodities and cyclical stocks.
2012
The 10-year yield topped between 3.6 and 3.8% during the spring of 2011 and then declined till the summer of 2012. There was a deceleration in economic growth but the biggest risk was the spiking sovereign yield on debt for European countries like Portugal, Ireland, Italy, and Greece. Bonds from these countries were held by many European financial institutions, and there were concerns of defaults and a cascading credit crisis.
The situation turned around as the ECB pledged that it wasn't going to let the Euro fail, and it would do "whatever it takes" to prevent that from happening. This led sovereign bonds to stabilize. In response to these issues and the weak economy, the Fed embarked on an "open-ended" QE program. The result was a steady melt-up in stocks for the next 2 years.
2016
Yields bottomed out following the surprise Brexit vote in 2016. However, yields had been trending lower since early-2014. There was a great deal of uncertainty about how the situation would play out with some calling for devastating consequences to Great Britain and the global economy. In hindsight, it's clear that this was a time to buy risk. The Federal Reserve entered 2016 with intentions to hike rates but held off given these developments. Following Brexit, the S&P 500
Today
Today's situation has eery similarities to the previous capitulation lows in bond yields. Both followed more than 12 months of yields trending lower due to global economic weakness. There are concerns that the coronavirus outbreak could have devastating, long-term economic consequences.
However, it should be noted that there are also some major differences. For one, the coronavirus threat is not a political situation like the European crisis or Brexit. Political situations are often solved if there is enough pain. Another difference is that stocks were not as overbought in the previous situation as they are now.
Given this current set of circumstances, traders and investors should be cautious in the short-term not to get chopped up in the market's gyrations. However, they should be mindful that in the long-term these types of extreme events mark inflection points in the market.
