Episode summary
The Bond Market May Be the Stock Market's Biggest Risk
The Markets
· · 12 min · Guests: Tony Pasquariello
Summary
Tony Pasquariello argues that the biggest near-term risk to equities is the bond market, not an immediate collapse in growth. He says the move in 10-year Treasury yields to new highs is adding pressure to stocks, and that if investors want to hedge equity exposure, shorting bonds may be the cleaner trade. He also says the current Fed tightening path looks more like a mini-cycle than a market-ending shock, unless policy ends up much tighter than the strip is pricing.
Pasquariello frames the backdrop as unusually pro-cyclical: an AI capex boom and a large fiscal deficit are both adding demand even as the Fed tightens. He says that helps explain why S&P 500 earnings growth has been "mind-bending," with earnings up 25% to 30% off easier comparisons, though he expects growth to slow to roughly 10% to 12%. That slowdown should reduce the market’s return slope, he says, but not necessarily turn returns negative.
He is more constructive on Japan than on broad U.S. equities. Pasquariello says the Japanese market combines shareholder reform, AI, advanced manufacturing, and defense exposure, and he favors a domestic, TOPIX-style trade over the Nikkei. The next major market test, he says, will be the payrolls report, which should help confirm whether the bond market’s pressure on stocks intensifies or eases.
Key takeaways
- Tony Pasquariello says the bond market is the "number one" clear and present danger for stocks, and short bonds may be the best hedge for equity risk.
- He expects S&P 500 earnings growth to slow from 25% to 30% to about 10% to 12%, which would still support gains but at a lower rate.
- Pasquariello thinks AI capex and a roughly $2 trillion fiscal deficit are offsetting some of the drag from Fed tightening.
- He says U.S. equity valuations are elevated versus history, but less stretched than in 1999-2000 because companies are more profitable and better capitalized.
- His preferred trade is Japanese equities, especially a TOPIX-like domestic exposure tied to shareholder reform, AI, defense, and re-industrialization.
Notable quotes
“If you were to ask me what's the number one kind of clear and present danger for the stock market, I'd say it is the bond market”
“you're talking about 25%, 30% earnings growth for the S&P 500 coming off great denominators”
“if I had to pick one horse to ride for the next phase of the game, I'm going Japanese equities with a bias towards the domestic”
How the episode opens
This is The Markets. I'm Chris Hussey, and today is Wednesday, September 23rd. And I'm here on the Goldman Sachs trading floor with Tony Pasquariello, who is global head of hedge fund coverage within FICC and Equities.
Tony, thanks so much for joining us. Great to be here. Okay.
You were with us almost exactly a year ago, and at the time, the Fed was actually cutting rates. Oh, what a difference a year makes. Walk us through what you make of both the Fed and the market's reaction, and how hedge funds were positioned going in and coming out.
Well, it's interesting. We started the year, and the market, the interest rate market expected there'd be a couple of cuts this year. Looks like there may be certainly a couple of hikes this year.
We are one, one hike into that. The strip's telling you there'll probably be about four hikes, maybe a touch more when all is said and done. So, we've ended up in a very different place.
You know, why is that? 66 months above target on inflation. Of course, what's going on in the Middle East has contributed to a rise in oil prices and refined products.
But also nominal growth has been very strong, so I don't think it's necessarily all bad in that context. Look, I thought the Chair reasserted kind of command of the narrative last week. Ultimately, he hiked.
It was a hawkish hike, and in the doing, the back end was kind of anchored in, inflation break-evens were anchored in, and I think it kind of became a clearing event for the stock market. And so up until Monday's close, it felt like that was, generally speaking viewed as a win by the stock market. As we sit here today, bond yields are pushing higher again, 10-year notes kind of making higher highs in yield terms relative to where they've been.
From the episode’s captions: roughly the first two minutes, lightly cleaned. Keep watching on YouTube →
Topics
- bond yields risk
- equity valuation
- hedging with short bonds
- s&p 500 earnings growth
- japan topix reforms
Companies and tickers mentioned
- GS
- Goldman Sachs
Watch the episode
Watch “The Bond Market May Be the Stock Market's Biggest Risk” on YouTube
Summary, takeaways and quote selection by Octagon. Quotes are short excerpts; the full conversation is in the episode.
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