Capital Markets Update #14

Sometimes so much can happen at once it can be difficult to generate a thesis.  The sheer magnitude of signal conflict can distort traditional relationships.  For instance, one might feel comfortable positioning around the idea that war leads to fear in markets.  Fear in markets usually translates to a rush to safety, often exemplified by an increase in demand for US Treasuries.  Demand for treasuries usually leads to lower treasury yields – all in all, a relatively logical daisy-chain.  However, today we’ve basically got a war, we’ve not really seen a significant outflow of capital from the equity markets, the aggregate S&P earnings outlook has been revised higher not lower, Treasury yields are up, and new Treasury auctions are weak.   

Rather than taking a stance on what will happen, we thought it may be helpful to explain our view as to what has transpired over the trailing month in the US capital markets.  We tend to think a quick peek over the shoulder, before turning forwards, is usually the more grounded, albeit conservative, way to evaluate capital markets during a period of dynamic change.  To maximize scope, we took a look at the S&P 500, US 2 and 10-year Treasury and US dollar market performance over the last month.   

We’re just about one-month into the joint US / Israeli effort in Iran.  If you follow the markets daily, you may have suffered a concussion; if you just woke up from a coma, you’d probably not care about your stock portfolio – but if you did, you’d likely think little of the month-over-month price action.  Despite the macro disruption, the S&P 500 is down 5.8% from the last close prior to commencement of hostilities and down 7.1% from all-time highs reached on February 2 (CNBC).  Admittedly, yesterday’s selloff hurt the metrics.  And yet, anchors abound for the equity markets.  Factors dragging markets down include concerns around AI debasing the enterprise value of software companies which collectively account for about 32% of the total S&P 500 market cap (New York Times), a 50% MoM rise in West Texas Intermediate crude prices (CNBC), a 40bp rise in the 10-year Treasury, a 55bp rise in the 2-year Treasury (CNBC), the first retail net daily outflow from equities since November 2023 (Vanda Research), and the emergence of a 13% chance of a Fed rate hike in June 2026 (CBOE).  The other side of this mound of pessimistic data is that 58.2% of “buy / sell / hold” ratings by S&P equity analysts are “buys” as of March 19th. That’s above the 5-year average of 55.6%.  If 58.2% holds through month-end, it will represent the highest rated market at any month-end going back to 2010.  Current earnings estimates expect approximately 12.5% YoY earnings growth as of Q1 2026.  Within the last week, aggregate earnings growth has been revised higher to 12.5% from 11.9%, primarily driven by stronger than expected memory chip sales.  Calendar Year 2026 earnings growth is expected to be 16.3%, which reflects an increase in the velocity of earnings growth through year-end 2026.  This, coupled with the fact that virtually every other market (other than the dollar) is down big and President Trump watches CNBC like a hawk, has basically helped throw a floor on equities during the present disruption. 

The US Treasury markets have experienced a similar level of discomfort to US equities.  However, like equities, much has led to relatively little.  As we noted earlier, 2 and 10-year Treasury yields are up noticeably, though not considerably.  However, following yesterday’s selloff, the 10-year yield is approaching that emotional 4.50% level we’re loathe to breach. We will note we were concerned to see the most recent 2-year Treasury Note auction settle a 2.44x bid-to-cover ratio.  This represented the weakest market demand for new-issue 2-year Notes since May 2024.  Basically, the Treasury saw particularly weak demand from both international and domestic investors, and was forced to offload about 24% of the securities to Primary Dealers (think big banks and financial institutions like JPM, Wells, Goldman, BofA, etc.). For reference, the average Primary Dealer take from the last six auctions was about 10.7% of securities sold (WSJ). These institutions have an agreement with the US Treasury such that they’ll buy all the securities the rest of the market won’t take at a competitive price.  Accordingly, larger Primary Dealer balances signal a weakness in demand from call it “core market participants” or (generically) foreign sovereign accounts buying Treasuries at competitive prices for their own reserves.   One might somewhat convincingly be able to attribute the auction weakness to particularly poor timing, as it coincided with a huge jump in both PMI and Import prices released on the same day as the auction, which agitated Fed Futures markets.  Either way, a 50% increase in the price of oil generally cultivates a fear of future inflation.  Inflation erodes the present value of fixed income securities, like US Treasuries, which, in turn, creates an understandable point of consternation amongst fixed income buyers.  Why buy something at a 4% yield today if inflation could eat nearly all of that return?

The one market which has provided a safe-haven for US dollar denominated investors is…the US dollar.  Price action in both the equity and debt markets has been negative, on balance, leading investors to seek refuge in the cash markets.  The irony is that our dollar markets are increasing in value in the face of renewed domestic inflation fears and a global pivot towards rate hikes.  Both factors are traditionally negative for dollar price.  Inflation erodes the value of a dollar and, generally speaking, when a foreign country increases its borrowing costs, it’s attempting to limit inflation, which in-turn props up the value of its local currency.  So, the fact that the dollar is up in this complex market environment is actually quite the achievement.  Wars aside, if you were to throw a domestic inflation shock and rate hikes within competitive currency markets at the US dollar, we’d likely expect to see it drop.   The fact it has not shows (in or view) that the current strength in the dollar market is really more akin to a port in a storm before re-embarking on a voyage, as opposed to a new home for conservative capital.  Potentially, this cash hording represents the springback capital we will want and need as clarity emerges on the geopolitical stage.  Cash can translate to bullish equity and debt capital quickly – just ask your stock broker.