Stock Market Implications of the Bond Margin Call

Olivier Le Moal

By Jeff Weniger, CFA

The bond market has had two difficult years.

The Bloomberg US Aggregate Bond Index began to decline, albeit gently, in August 2020. Last year the grind continued, with the index falling at a frightening but boring pace. 1.7%.

Then came 2022.

With the index down more than 10% this year, bond investors are bracing themselves for an omen that’s been rare, at least since I’ve been in this industry: three quarters in a row of red ink in fixed income brokerage statement page. This may or may not happen – bonds were down 0.06% in July and August, so a small rally in bonds in September would end the streak.

Nevertheless, 2022 has been weird. In “normal” times, one would expect bonds to thrive in a weakening economy. But this year, that old truism was thrown out the window.

The NASDAQ is inspired by the long bond yield. It is down 23% and the S&P 500 Growth Index is following it with a loss of 21%. This puts into perspective the relative safe haven status of the S&P 500 Value Index, which fell “only” 7%.

Figure 1: NASDAQ is pegged to bond yields

NASDAQ is linked to bond yields

The stock market results look suspicious. I think this is a problem for very high beta stocks which tend to fill growth baskets.

Consider this. The New York Fed’s Q3 Senior Loan Officer Survey found that 14% of US banks are tightening their lending standards. In Figure 2, we can see three episodes over the past quarter century in which this measure deteriorated from a sharp easing to a sharp tightening of this magnitude. These episodes took place in 2000, 2007 and 2020 – all good times to predict that revenues would decline.

Admittedly, I don’t know if drawing a comparison to the global financial crisis is warranted at this stage of the game, so take that with a grain of salt. Nonetheless, a scenario that sees S&P 500 earnings growth decline in 2023 is plausible, reasonable, and possible.

Figure 2: Tighter bank lending standards bode ill for S&P 500 earnings

Tighter bank lending standards bode ill for S&P 500 earnings

If that were to happen, we would have a situation where the entire yield curve could follow the Fed’s rate hike, while at the same time equity investors find little solace in earnings reports.

We don’t know if the current relationship will hold, but it seems to me that if the bond market wants to sell and S&P earnings want to lay an egg, then growth stocks are a problem child in 2023.

In other words, growth stocks are now the anti-diversification and pro-concentration asset class. As the bond market receives its proverbial margin call, there may come that moment every investor dreads: scrolling through the list of holdings to find something to sell.

If it’s the Bloomberg Aggregate that’s giving investors headaches in the months and years ahead, maybe it’s the NASDAQ-style holdings that hit the sell button. If the bond market action continues to penalize growth stocks, our dividend strategies could represent something of a safe haven.

Unless otherwise stated, data is as of 08/30/22.

Jeff Weniger

Jeff Weniger, CFA, Head of Equity Strategy

Jeff Weniger, CFA, is head of equity strategy at WisdomTree. In his role, Weniger helps formulate the company’s stock market outlook by assessing macroeconomic and fundamental trends. Prior to joining WisdomTree, he was Director, Senior Strategist at BMO, where he worked in the Office of the Chief Information Officer from 2006 to 2017. He served on the company’s Asset Allocation Committee and co-managed the firm’s model ETF portfolios for the United States and Canada. In 2013, at the age of 32, Jeff was chosen as the youngest member of BMO’s Global Investment Forum, which brought together the firm’s top global strategists to formulate the official long-term outlook for the company for investment trends and markets. Jeff holds a BS in Finance from the University of Florida and an MBA from Notre Dame. He is a CFA charter holder and a member of the CFA Society of Chicago since 2006. He has appeared in various financial publications such as Barron’s and the Wall Street Journal and makes regular appearances on Canada’s Business News Network (BNN) and Wharton Business Radio .

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

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