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Kashyap’s Mid-February 2023 Market Outlook

Divergence between stocks and bonds. Rocket scientists vs degen gamblers. Who will be right?

Yields on 30Y treasuries peaked on 10/24/2022 at 4.425%. 10Y yields peaked at 4.333% on 10/21/2022. 5Y yields peaked at 4.499% on 10/21/2022. The 30Y peaked with a lag. S&P (ES) bottomed at 3530.99, Dow (YM) at 30,435, and Nasdaq (NQ) at 10,589.39 on 10/13/2022 when the inflation print came out higher than expected, stoking fear of rate hikes. October was the bottom for stocks and bonds.

Did they all start going higher immediately? No. Nasdaq put in a further triple bottom in November, December, and January, while ES and YM went straight up. On the back of massive fear and investors selling everything. 5Y yields put in a double top in November while 10Y and 30Y had a mild retracement. Yields rose in the second half of December. Predictably, that was a tough period for stocks as well.

See the pattern? Stocks like yields falling. The starting point does not matter. Stocks have gone down with rising yields and gone up with falling yields – until now. Now, stocks are rising while yields are soaring. No exaggeration – while the bond bulls roll over and die, the stock bulls are making a buttload of money.

That’s a screaming divergence.

How to reconcile this?

One market or the other has it wrong. Either yields should slide and bonds should rally so the stock market can power through and make a fresh 2023 high. With the debt ceiling standoff halting new Treasury issuance, bonds should theoretically be catching a bid in the secondary market, but aren’t. Which means the CPI print has changed investors’ expectations on the future path of interest rates. The surprise higher in January inflation, followed by strong retail sales, and the persistently strong job market and wage growth (not according to me, but according to the Bureau of Lying Statistics) has caused the yield curve inversion to flatten out a bit by taking long rates higher.

For all practical purposes, a stock is no different from a 30Y bond. The terminal value of a stock 30 years out, discounted to the present, has about as much weighing in the NPV as the principal from a 30Y bond at maturity. Quibble at the math all you want, but I’m just making a broad point. If you buy my argument, the discount rate to be used for calculating the NPV of a stock’s future earnings stream should be the yield of the 30Y treasury, i.e., if you assume the stock carries the same risk as a US government bond backed by the power of taxation and the printing press. Maybe the discount rate on stocks should be a tad higher, but it’s at least on par. That discount rate has moved 8.4% higher from the low of 3.555% on 2/2/2023 to 3.854%.

That translates into a NPV change on a $100 zero coupon 30Y bond from $35.06 to $32.16. The bond market, filled with quants, rocket scientists and smart guys with PhDs in mathematics and physics has priced this in. A growth stock which pays no dividend and is assumed to grow into its valuation over a long time period, has not. Crypto, which is a pure bet on adoption (another word for growth), has not. The longer the time period from now until pay-off, the more the stock or other asset should have sold off in response to rising yields. But the market is pricing the $32.16 worth asset as if it’s now worth $40.

In fact, we’ve seen something strange happen. Stocks of companies which have filed for bankruptcy are the best performers, with companies that are on the verge of bankruptcy coming in a close second.

Ironically, the stocks which actually put money in shareholders’ pockets and carry 10%+ dividend yields are making new lows. Using the same bond analogy, the current NPV of a $100 10% coupon 30Y bond is $208.19. You have to account for dividend cuts, loss of business and the like, but using that logic the same applies to growth stocks which are pricing in a glorious future with adoption rising as far as the eye can see. Even within stocks, there’s a divergence, with the stocks favored by people with “old DNA” trading at low multiples and fat yields, while the stocks favored by the Exponential Age “new DNA” thinkers are outperforming. I know value looks at the past and growth looks at the future, so there will always be a difference in valuation between the two types of stocks. Here, I’m taking about the divergence persisting even when you input numbers into the DCF model to account for growth rates.

Said differently, if you think industrial and old economy stocks are priced right, then you’re really optimistic about growth rates if you think technology and other growth assets are priced right. Which is fine as far as that goes, but it goes to show that the “old DNA” stock investors and “new DNA” Exponential Age stock investors see today’s environment very differently. That’s yet another divergence.

New DNA stock guys, old DNA stock guys, and bond guys all see the same prices, but interpret them as differently as the blind guys with the elephant. Except, they actually see the elephant and still aren’t convinced they are seeing the same elephant.

The argument that the market is pricing in a Fed pivot no longer holds. The rejoinder is which market – stocks or bonds (and which stocks)? Bonds are most definitely not pricing in a Fed pivot or anything close to it. Remember the taper tantrum in 2013 when the Fed announced that it was ending QE?

The market should be in a taper tantrum now, with all hopes of a Fed pivot dashed.

But, it’s not.

The uptrend in stocks is intact on the daily charts. Crypto is going bananas like it’s “money printer go brr” time. All while the bond market is screaming recession and bloody murder.

Let’s look at the four ways of positioning between stocks and bonds.

“Short bonds and long stocks” is logically inconsistent. Even if you foresee a Fed pivot, the right trade is long the 2Y and long stocks.

“Long bonds and long stocks” is consistent with the expectation of an imminent Fed pivot.

“Short bonds and short stocks” is a bet on rates continuing to rise, triggering an Austrian style deflationary collapse and The Great Reset. It is also consistent with the expectation of an inflationary collapse like the 1970s. This strategy needs the economy to move towards extremes, from stability to instability, in a short timeframe.

“Long bonds and short stocks” is a bet on the divergence I’ve been taking about narrowing. Best outcome, stocks sell-off and bonds rise to close the gap. Worst outcome, stocks rise but yields cool off and making or losing money comes down to how you structure the trade.

This is my framework. My positioning keeps switching based on the shift in yields and the Nasdaq. Right now (16th Feb pre-market), I favor short stocks and long bonds.

As a self-taught Austrian economist, I prefer a deflationary collapse that would heal the system and prevent excess debt from being a millstone around the neck of the younger generation. But I play the hand I’m dealt, so short stocks and long bonds it is. For now.

Disclaimer: Not investment advice.

For consulting appointments, e-mail me at

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