Bear markets are funny things. They tend to start small, and isolated, and then suddenly they become a big problem. Almost all the talk now is about whether the AI “bubble” is bursting. From the numbers being reported out of Google last night, maybe you could argue this is as good as it gets, but bursting seems a stretch at the moment. The backlog number and token usage numbers look great to me.
My working theory on markets was that growth would be good (see Google numbers above), but the cost of capital would rise. And this rising cost of capital would be the problem for markets. This has already been a problem for parts of the market. Private equity and private credit equities have traded poorly. Invesco Private Equity ETF is pretty indicative.
But for broader markets, things have been okay. Generally speaking the S&P 500 tends to follow HYG US - the high yield ETF. When this is falling - equities don’t do so great.
First of all, the 200MDA on this is now inflecting lower, like it did back in 2022. Secondly, HYG is falling even though credit spreads are tight. To restate what HYG says, when credit spreads widen, equities don’t do so great. Currently we are near life time lows on spreads.
Another measure of credit is the leverage loan index. This is pretty heavily tied to private equity, and again when this is going lower, bad things tend to happen. This tends to match up well with movement in the Invesco Private Equity ETF. It was weak at the beginning of the year, stabilised, but not able to get back to old highs as it has done before.
What all of this credit metrics do not need would be a treasury sell off. As pointed out, credit spreads are probably TOO tight. The US 5 year is really having a good look at breaking higher.
What I am saying is that conditions for a bond market led sell off in equities are starting to look ideal. The best example is more like 2022, which was a repricing of assets, rather than collapsing revenue or earnings. How bad could it get? Its a tough question. The relationship between rising government bond yields and US equity valuations has been unstable of late. In 2022 it seemed to matter, but since then, not so much.
The big issue is that the US government would be forced to raise more revenue. Stealing a graph from Grizzle on Substack shows the problem.
Looking at US interest payments highlights the problem.
What I am trying to say is that AI trade will someday come to an end, as all trades do. But bear markets tend to come from areas that people know are problem, but are no longer invested in. People know that private credit is bad, they know that private equity is bad, they know the government is bankrupt, so they have already minimised their exposure there. The problem is that it is very hard for markets to ignore higher sovereign yields. I think the next sell off in sovereigns will be particularly problematic as it will likely send a number of hedge funds doing the treasury basis trade bankrupt overnight. I live in hope.
