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Well received earnings from Amazon, Alphabet and Microsoft have injected even more momentum to a rally in technology stocks that has already trounced every other part of the US stock market this year. The S&P 500 Information Technology Index has soared 36%, while the S&P 500 is up 15%.
Yet this tech rally is fundamentally different from the dot-com boom of the late 1990s when many of the stocks were rising on the fumes rather than on earnings. Equity investors need to keep a keen eye on the credit markets. The latter is flush with liquidity as money continues pouring into high grade bond funds in search of juicier yields. That's a very supportive backdrop for stocks.
Rich credit markets and low bond yields largely reflect the intervention central banks have made in markets since the financial crisis. However, according to Bank of America Merrill Lynch, March will mark the month of peak liquidity as the central bank balance sheets reach $15.3 trillion. The clock is ticking on the rally.
For some time, dividend-paying stocks have been the new fixed income. It's a trend that began as the US Federal Reserve tamed inflation during the 1980s. It gathered pace over the last decade as the conundrum of low bond yields confounded investors. In the wake of quantitative easing, and the most aggressive suppression of bond yields seen since the 1940s, owning dividend-paying stocks has truly delivered in keeping investors ahead of inflation.
US government bond traders have been riding a powerful trend for some time. Sell shorter dated two- and five-year notes, and buy long-dated debt, such as the 10- and 30-year note. The popularity of the trade has sharply narrowed or flattened the difference between yields on short and longer dated bonds.
The shape of the yield curve is important and closely followed by investors as a barometer of what it suggests for the broader US economy's prospects. A flatter yield curve signals weaker expectations for growth and inflation. Given the scale of the current flattening trade, there is scope for some reversal but that may only gain momentum if the Federal Reserve policy makers, at some point, scaled back their projections for tightening policy next year.
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