Lower Treasury yields have supported equities

The note attached here assesses the role that lower Treasury yields have played – and may play – in protecting the equity market from the COVID shock.

Lower yields have almost certainly allowed equities to incorporate a higher risk premium with only a limited decline of price.  Moreover, this influence is fundamental and durable, rather than something to be dismissed as ephemeral, like TINA, which can sound bubble-headed.

Some versions lower of Treasury yield story incorporate the notion of “financial suppression”, as if such suppression would actually be bullish risk-assets in this case.   That part of the thesis seems mistaken, but in a way that is so convoluted that it is probably best left aside for now. I plan to address it in a follow-up background note. (For now, bulk delete.)

The issue looking forward is that even if these lower Treasury yields are durable, as I expect, they cannot provide much additional support from here, simply because of the proximity of the lower bound on rates, which the Fed seems likely to respect – and to be expected to respect.  Meanwhile, the fundamental drivers of the equity premium seemingly continue pushing for it to rise, at a time when the market-implied premium is not particularly high.

Moreover, the secular backdrop of “moderation”, which I have long presumed sets the relevant valuation benchmarks (of cheap, rich and fair) seems likely to persist but is not actually guaranteed to.

So, this situation still looks dangerous and confusing, although without presenting a compelling case for being short.  As I see it, the sun is not currently shining.