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October 9, 2023 - When will the "bond vigilantes" be stopped ?

The phrase “bond vigilantes” was coined four decades ago, by Ed Yardeni, of Yardeni Research and has become since then very familiar in the investment community. He first wrote about the bond vigilantes in 1983, during a similar period of high inflation and irresponsible government spending which led to high fiscal deficits: “So if the fiscal and monetary authorities won’t regulate the economy, the bond investors will. The economy will be run by vigilantes in the credit markets.” What we mean by "bond vigilantes" is all the market participants (hedge funds, speculators, traders) who decide collectively to bet against the bonds of a particular issuer, whether this is a company, a country or a region. Greece in 2011 is such an example, where the investment community started selling en-masse the Greek government bonds, as the high levels of debt and the high deficits were "suddenly discovered" as a serious threat for the sustainability of the debt. The end result of these attacks is yields sky-rocketing higher, which means borrowing costs of the issuer increasing significantly and in some cases this could lead to an eventual bankruptcy. The bond vigilantes gain because they have sold the bonds "short", meaning that they profit from the prices collapsing (as the yields rise) and they buy the bonds back at much lower prices.

After the US government debt rating downgrade by Fitch in July, the vigilantes seem to have woken up again. High inflation, high levels of debt, high fiscal deficit, higher interest rates and the FED itself selling bonds from its own portfolio, appear to be the perfect conditions for them to attack. It is not really a surprise that the long-term yields started moving higher (bond prices moving lower) since the days of the debt ceiling discussions and the eventual downgrade. Of course, their target is not to drive the US into bankruptcy as this is almost impossible, but just to make a good profit . The recent FED announcements with regard to the path of interest rates in the next 6-9 months, as well as the ousting of the Republican House Speaker, Mr. McCarthy, by his own colleagues, simply added fuel to a fire which was already starting to burn, essentially inviting more vigilantes to join the "party" and hedge funds to discover a new theme: "short the government bond market".

Fortunately, these people do not make money forever, and they are burned more often than not. Our readers should not forget that these speculators are short the bonds, which means that they have to buy them back in order to crystallize any profit. Buying back the bonds means that they now become buyers and any move higher in price, will make them buy more and more to cover their shorts, pushing prices even higher. The current sell-off in bond prices has created tremendous opportunities for ordinary investors like us, who wish to place cash in high quality bonds and keep them for the next 3-5 years, earning safe income of more than 4% in EUR and more than 6% in USD, not worrying a lot about the day-to-day volatility. And if the vigilantes burn themselves, then the investors who bought at today's prices will be happy to see that their bonds have also appreciated in price ( a lot). We should also note that the recent rise in yields of more than 50bp in the long-end might take away the need for an actual rate hike by the FED until the end of the year, which is another reason why we think that current levels are attractive. Needless to say, that if the current, tragic situation in the Middle East escalates further, bonds will rally and the rally will be exaggerated by the process of short covering, we described above.

The US labor market continues to defy logic and send mixed signals. The September monthly non-farm payrolls were announced at a whopping 336k vs expectations of 170k and compared to a revised upwards 227k number in August. However looking into the details, 70% of these gains were in just three sectors: government, healthcare, and hospitality/leisure. Job gains in professional services, such as architects, marketers, engineers and managers, rose by just 21,000 jobs, less than half the number from September 2022. The private ADP jobs number published on Wednesday also painted a "not-so-strong" picture. According to this survey, only 89k payrolls were added in September, which is the lowest level in almost three years. But, on Tuesday the JOLTS job openings number was very strong, jumping to 9.6mn from 8.9 in the previous month. And at the same time, wages' growth continues to move lower (4.2% vs 4.3% in the previous month and compared to the high of 5.5% a few months ago) , which is positive for inflation and of course not consistent with a tight labor market. Unemployment remained at 3.8%.

Equities had another negative week, except for Nasdaq (+1.5%) which also helped the S&P500 eke out small gains (0.5%). The S&P500 successfully tested its important 200-day moving average on Friday, from which level it staged a big rally. Europe fell by 1% on average, while the Athens Stock Exchange slumped by almost 6%. In terms of sectors, the Food&Beverage got hammered as a a new theme emerged on how the Americans are going to change their eating and living habits, which will impact growth of these companies in the next decades. Although we agree with the structural trend towards a healthier lifestyle, the global leaders in this industry (Nestlé, Pepsico, Diageo, Heineken etc) enjoy growth from the growing global population, the growing middle class and the global need for food and drinking. They are already trading at the lowest valuation in almost ten years. We see in these stocks great opportunities to buy, while others are searching for what could go wrong with them in 2030 or 2040.

Oil prices fell significantly and are now more than 10% lower than two weeks ago, but the developing situation in the Middle East could complicate things again. The WTI Crude Oil futures traded as low as 82$, down from their recent peak close to 94$, with no news or any other development. The same market participants who drove its price relentlessly from below 70$ to almost 100$, using as an excuse that China will embark in big infrastructure programs to boost the economy and that the consumer is strong and resilient, perhaps now realize that the consumer is cutting back on expenses and Europe could enter a recession by the end of the year (Germany being already in recession). We do not really have a view on oil prices, rather than that the 90-100$ levels mean a strong global economy or a war.

The 3rd quarter corporate results are set to begin this week in the US, with the major banks first to report among others. On aggregate level the earnings per share (EPS) for the S&P500 are expected to show little change vs. the same quarter of last year. If this proves to be the case, it will be the fourth consecutive quarter of negative or no growth for US equities, in terms of profits. The estimate is now at 55.3$ and as a reference it was at 58.3$, when we started the year. This means that analysts had over-estimated expected profits by more than 5%. Looking into the details per sector, one can see that Technology related companies have upgraded their earnings estimates significantly, primarily due to Nvidia's artificial intelligence related surge in revenues and profits. On the contrary, Materials, Industrials and Health Care earnings have been revised lower.

Chart of the Week : Swiss stocks are too cheap to ignore.

The above chart shows the evolution of the Swiss equity index (SMI) in blue and its valuation, as expressed through its forward P/E (price-to-earnings) in dotted green, for the last 10 years. We also show in circles, the periods during when in those last 10 years, the valuation was at similar levels, and one can see the big rally that followed in the next months-years. Choosing to ignore the day-to-day volatility and looking ahead 12-18 months, the current levels of Swiss large cap stocks appear to be at very attractive levels. As a bonus, investors who buy stocks of these high quality companies gain exposure to the Swiss Franc, which although it is close to record highs against the EUR and the USD, is expected to eventually move even higher and also offers protection against any future episode of geopolitical or financial nature.


• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Chart of the Week : Factset . Photo: https:


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