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If Wall Street legend Bob Farrell’s first rule for investing holds true in the current market environment, it may mean the Treasury yields have peaked, while stocks are poised to fall from here, according to David Rosenberg, former chief North American economist at Merrill Lynch and now president of Rosenberg Research.
“Markets tend to return to the mean over time,” Farrell said at the start of his 10 rules for investing.
For now, financial markets are at one of the short-term turning points, Rosenberg wrote in a Tuesday note.
Earlier this month, the 10-year Treasury yield
BX:TMUBMUSD10Y
rose to close to 5%, the highest level since 2007, before pulling back to 4.874% on Tuesday. The yield is likely to continue to fall, noted Rosenberg.
Historically, recessions followed the end of monetary tightening phase by the Federal Reserve, while it on average takes about two years for a recession to start after the Fed’s first interest rate hike, Rosenberg noted. It means that there could be more “definitive recession signs” in the first half of 2024, he said.
During recessions, the 10-year Treasury note yield fell an average of 150 basis points, based on historical data, said Rosenberg.
Haver Analytics, Federal Reserve, Rosenberg Research
Meanwhile, the yield curve has been inverted for more than a year, an “abnormal” condition that only happens 15% of the time in history, Rosenberg noted.
If the curve reverts to its mean of the past two decades, it would imply the 10-year Treasury note yield standing at 3%, meaning government debt could see a 16% gain in a twelve-month period, Rosenberg said. Bond prices and yields move in opposite directions.
Haver Analytics, Rosenberg Research
The homeowner affordability ratio is also 35% lower than it has been in the past, even below its level during the 2006-2007 credit and housing bubble. To mean-revert the number, “virtually all combinations of [house] prices and interest rates lead to lower yields,” Rosenberg noted.
In addition, the equity risk premium, which measures the excess return investors get from owning stocks over Treasuries, is falling towards zero for the first time since 2002, Rosenberg noted.
A mean reversion of the index would imply, “as a base case, the S&P 500 correcting further, to around 3,200 or 3,300, and a coincident adjustment lower in the 10-year Treasury note yield to a 2.5%-3.0% band,” Rosenberg noted.
U.S. stocks ended higher on Tuesday, with the Dow Jones Industrial Average
DJIA
up 0.4%. The S&P 500
SPX
rose 0.7% and the Nasdaq Composite
COMP
gained 0.5%, according to FactSet data.
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