Today's massacre in money markets has seen global bonds crushed but US Treasuries dramatically underperforming. In fact, as Gavekal Capital's Eric Bush notes, the last time the spread between US and German 10-year government bonds had such a large yield differential was on May 10th, 1989, as in before the fall of the Berlin Wall.
The official date that the Berlin Wall fell is November 9th, 1989. Let that sink in for moment.
And it’s not just 10-year bonds that are sitting at historic levels. The 5-year yield differential is at the widest level on record going back to 1997.
Over the past decade, a wider spread has been positive for US stocks. The correlation over the past decade between the spread in US-German government yields and the S&P 500 has been a significant 89%.
If we replace the S&P 500 with the P/E ratio for the S&P 500 the correlations remains a robust 81%.
Our data on US and German 10-year yields goes starts in 1972 and since then the average spread has been 80 bps. From 1972 to 1979 the average spread was -26 bps (i.e. German bunds were yielding more than US treasuries on average). From 1980-1989, the average spread was 265 bps. And from 1990-present, the average spread has been 31 bps. We bring up these averages to point out that this relationship isn’t static and it does change over time.
The question facing investors is this: are we entering a period where US growth/inflation prospects (or maybe a lack of German growth/inflation prospects) support a 1980s spread level?
- If the answer to that question is ‘yes’, then we could see this spread move considerably higher which could be supportive of US stock prices and valuation multiples.
- If, however, the answer is ‘no’ then we would expect this relationship to fall back towards the mean that has been in place since 1990. This would suggest that either US bond yields will need to fall significantly or German yields need to rise by quite a bit. Either way, this mean reversion scenario is probably an anchor on US stocks and equity valuations.
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