Bond Market Commentary

Huge or Hype?

By Doug Drabik
May 14, 2019

You don’t have look too hard to obtain differing opinions on the markets. After all, different points of view, various data interpretations and emotions can change the course or market’s direction. Clearly the markets are not an exact science.

The latest media hype is the trade war between China and the U.S., the world’s two largest economies. If you have a point of view, you can locate an article to back your view: anything from why the trade war is huge to the trade war hysterics. My years of experience in this business have taught me much, one such highlight is that reality is not necessarily the catalyst which moves markets. If enough people believe in something, if abundant models prompt a response and/or if the media endorses a notion, the markets can and will likely react. In a 1996 televised speech, the then Federal Reserve Board chairman, Alan Greenspan, coined the phrase “irrational exuberance”. At the time he referenced the known status of low inflation which implied the potential for higher prices of earning assets but warned that we may not be able to determine when asset values become “unduly escalated”. The notion of factually based yet emotionally charged exaggeration in the markets has been going on forever: from Holland’s 17th century Tulip Mania to the more recent Bitcoin Currency.

What seems lost in the trade war rundown is its underpinning basis. Many experts will argue that for years, China cheated and stole their way into an unfair advantage. Most of this centers around China’s theft of intellectual property. Developing products and innovations can be an expensive endeavor. Corporations spend billions of dollars in research and development. Skipping right to production is an obvious advantage. According to the CIA World Factbook, China’s GDP per capita is $16,600 while the U.S. GDP per capita is $59,500. You can pay a laborer in China much less due to their lower cost of living. The net result: producing a product is cheaper in China than in the U.S. for fair and unfair reasons. The rationale behind the U.S. position: level the playing field.

The International Monetary Fund reports the U.S. GDP at ~$20.5 trillion, roughly 53% larger than the world’s second biggest GDP, China’s ~$13.4 trillion. The U.S. imports about $580 billion from China representing roughly 4.3% of their GDP. China imports about $179.2 billion from the U.S. (which is 0.9% of U.S. GDP). The trade talks are disproportionally important. Imports from China represent around 18% of the U.S. total imports and many observers point out that most of these imports can be obtained from other countries.

The facts cannot be isolated as we point out the potential exuberance behind market behavior. Some may argue that the markets were overly excited about the assumed trade compromise weeks in advance bringing interest rates down and equity markets up; therefore, yesterday’s correction is not so surprising. The power of persuasion and markets exuberance has history on its side. What might be a fair assessment is that eventually, time brings rationality back to the markets. Although it is a much tougher process for equity evaluation and timing, fixed income requires discipline, not predictability.

A portfolio’s allocation to fixed income should not be substituted for all the behavioral rationales discussed above. A trade war translates to a consumer tax. The free markets will eventually seek the level at which consumers support that tax. The current trade war in itself is not significant to the overall U.S. economy yet the exuberance will likely continue to effect the markets. Don’t lose sight of long term fixed income investing or alter your fixed income portfolio based solely on this trade war hype.  


To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.