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Why are bond yields so low and stock prices so high?


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Does anyone have any thoughts on what the bond market and the stock market are currently telling investors? In the US long bond yields have been coming down for the last eight months. They certainly seem to be forecasting much lower growth moving forward. The stock market on the other hand is 5% from its highs and seems to see solid economic growth moving forward. The two perspectives do not seem to line up.

 

My view is the bond market tends to give investors better information than the stock market over the short to medium term.

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Guest cherzeca

good question.  seems that there is still a huge demand for risk avoidance, a continuing effect of FC, which is reflected in bond market.  for those willing to stomach risk in equity market, the price for risk is high (return low) given low discount rate established for the equity market by the bond market.

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Myron Scholes had an interesting Bloomberg article. The corporate bond yield curve is steeper than average, even though the government bond yield curve is inverted.

 

Another Bloomberg article, (I think by Myron Scholes again), pointed out that absolute short-term bond yields are very low compared to inflation. Historically, a recession requires short-term bond yields to be much higher than inflation compared to the current spread.

 

The main thrust of both articles was that the government yield curve is not meaningful due to QE. Central banks pinning down government yields everywhere. Retreat from QE is too painful politically. Hedonic adjustments will make sure "inflation" stays pinned to 1.5%.

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Rulenumberone, how does QE explain the rapid decline in long bond we have seen in the past 8 months? My guess is the Fed is pretty predictable over time with its actions. Are non government players are responsible for driving yields much lower recently?

 

It looks to me like the stock market is getting the message a little later than the bond market.

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While I dont disagree with much of the sentiment, at least on an academic level, what I think is flawed is the notion that equity risk is high relative to future returns. Granted, no one knows the future, but people have been saying this for at least the last half decade and returns have been more than adequate. There is little reason this can not continue to be the case. At least not any more reason than there is to make the case that it can not continue.

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The US economy is very strong right now. I believe European institutional investors have bought as many Treasuries as their regulators would allow. Apart from the extra yield in the US, USD/EUR is promising due to terrible economic prospects for Europe compared to the US.

 

Something bad is going on in Europe, but Europe has been that way for the last 7 years. Here are European 10-year yields today, only Italy and Greece have a yield comparable to the US.

 

 

COUNTRY YIELD 1 DAY 1 MONTH 1 YEAR TIME (EDT)

Germany »  -0.18% -1 -18 -43 11:42 AM

United Kingdom »0.89% -2 -26 -29 11:42 AM

France 0.22% -2 -14 -42 11:42 AM

Italy 2.64% -4 +6 -51 11:42 AM

Spain 0.73% -5 -28 -86 11:42 AM

Netherlands 0.01% -2 -17 -45 11:42 AM

Portugal 0.85% -7 -27 -131 11:42 AM

Greece 3.11% -4 -17 -161 11:41 AM

Switzerland -0.49% -2 -14 -32 11:41 AM

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I agree there is speculation in tech stocks. FT has prepared a long list of such companies titled "when is the crash?"

https://ftalphaville.ft.com/2019/03/27/1553662858000/The-cloud-software-kings-are-nuts--when-s-the-crash-/

 

But something like WFC is rock-solid. In 4 weeks, they will announce a buyback of 10% of their market cap plus a 4% dividend yield. The US economy is very strong and will stay that way.

 

The rest of the world has never impacted the US economy, simply because the exposure to the rest of the world has always been very small here.

 

 

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Guest cherzeca

I agree there is speculation in tech stocks. FT has prepared a long list of such companies titled "when is the crash?"

https://ftalphaville.ft.com/2019/03/27/1553662858000/The-cloud-software-kings-are-nuts--when-s-the-crash-/

 

But something like WFC is rock-solid. In 4 weeks, they will announce a buyback of 10% of their market cap plus a 4% dividend yield. The US economy is very strong and will stay that way.

 

The rest of the world has never impacted the US economy, simply because the exposure to the rest of the world has always been very small here.

 

wfc will buy back 10% of common stock over the fed's dead bodies

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The US economy is very strong right now. I believe European institutional investors have bought as many Treasuries as their regulators would allow. Apart from the extra yield in the US, USD/EUR is promising due to terrible economic prospects for Europe compared to the US.

 

Something bad is going on in Europe, but Europe has been that way for the last 7 years. Here are European 10-year yields today, only Italy and Greece have a yield comparable to the US.

 

 

COUNTRY YIELD 1 DAY 1 MONTH 1 YEAR TIME (EDT)

Germany »  -0.18% -1 -18 -43 11:42 AM

United Kingdom »0.89% -2 -26 -29 11:42 AM

France 0.22% -2 -14 -42 11:42 AM

Italy 2.64% -4 +6 -51 11:42 AM

Spain 0.73% -5 -28 -86 11:42 AM

Netherlands 0.01% -2 -17 -45 11:42 AM

Portugal 0.85% -7 -27 -131 11:42 AM

Greece 3.11% -4 -17 -161 11:41 AM

Switzerland -0.49% -2 -14 -32 11:41 AM

 

I believe this to be correct. The QE in Europe has driven LT interest rate to zero and worse, which makes the 2.x% in the US a great deal now, comparatively speaking.

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Does anyone have any thoughts on what the bond market and the stock market are currently telling investors? In the US long bond yields have been coming down for the last eight months. They certainly seem to be forecasting much lower growth moving forward. The stock market on the other hand is 5% from its highs and seems to see solid economic growth moving forward. The two perspectives do not seem to line up.

 

My view is the bond market tends to give investors better information than the stock market over the short to medium term.

 

Imo this is a common misconception.  Perpetual lower bond yields/growth lead to HIGHER stock multiples.  I guess one could argue over whether growth will be perpetually lower or just temporarily lower.  I think with the low inflation target, and lower population growth going forward, that we indeed will have lower (nominal) growth going forward and that stock multiples with therefore be higher than they've been in the past.

 

As Buffett said: "if you had zero interest rates and you knew you were going to have them forever, stocks should trade at 100 or 200 times earnings".

 

 

Lower interest rates = Higher P/E ratios

 

Would also add that, in general, QE leads to higher interest rates not lower interest rates.  Europe has low rates because they haven't done enough money printing...ECB monetary policy has been much tighter than US, hence Europe has lower rates

 

 

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Does anyone have any thoughts on what the bond market and the stock market are currently telling investors? In the US long bond yields have been coming down for the last eight months. They certainly seem to be forecasting much lower growth moving forward. The stock market on the other hand is 5% from its highs and seems to see solid economic growth moving forward. The two perspectives do not seem to line up.

 

My view is the bond market tends to give investors better information than the stock market over the short to medium term.

 

Imo this is a common misconception.  Perpetual lower bond yields/growth lead to HIGHER stock multiples.  I guess one could argue over whether growth will be perpetually lower or just temporarily lower.  I think with the low inflation target, and lower population growth going forward, that we indeed will have lower (nominal) growth going forward and that stock multiples with therefore be higher than they've been in the past.

 

As Buffett said: "if you had zero interest rates and you knew you were going to have them forever, stocks should trade at 100 or 200 times earnings".

 

 

Lower interest rates = Higher P/E ratios

 

Would also add that, in general, QE leads to higher interest rates not lower interest rates.  Europe has low rates because they haven't done enough money printing...ECB monetary policy has been much tighter than US, hence Europe has lower rates

 

Jim, i agree that generally speaking lower bond yields should support higher PE multiples. Given the abrupt and large move lower in US yields i am wondering if the bond market is forcasting slower global growth moving forward; this will result in lower earnings for companies and usually leads to lower equity prices.

 

I am just surprised at the abrupt pivot in the thinking of bond investors. 12 months ago all the talk was how 10 year yields in the US would be pushing 3.5% and perhaps even 4%). Today we have 10 year rates below 2.3% with some saying they may fall below 2%. I am just trying to understand what is driving the pivot. The stock market looks oblivious to what has been going on in the stock market and i find this interesting.

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I agree there is speculation in tech stocks. FT has prepared a long list of such companies titled "when is the crash?"

https://ftalphaville.ft.com/2019/03/27/1553662858000/The-cloud-software-kings-are-nuts--when-s-the-crash-/

 

But something like WFC is rock-solid. In 4 weeks, they will announce a buyback of 10% of their market cap plus a 4% dividend yield. The US economy is very strong and will stay that way.

 

The rest of the world has never impacted the US economy, simply because the exposure to the rest of the world has always been very small here.

 

wfc will buy back 10% of common stock over the fed's dead bodies

 

1) Agreed. WFC isn't going to buyback anywhere near that amount with the regulation and scrutiny they currently have.

 

2) The idea that the rest of the world has never had an impact on the U.S. and never will is terribly short-sighted. The globe used to be dependent on U.S. economic strength. Now the globe is dependent on credit creation in China. Further, the U.S. is hardly "very strong". As has been pointed out by a few, nominal economic growth has been less than nominal national debt growth in the U.S. for the last several years - i.e. without gov't spending/borrowing trillions more than it had, GDP would have been negative. This is obviously unsustainable and in no way indicative of a "strong" or "self sustaining" economy.

 

And despite trillions in stimulus spending, tax cuts, and QE, we still haven't been able to spur growth above what would've been considered paltry pre-crisis nor have we had any appreciable amount of inflation despite generational low unemployment. Methinks all of these factors are still trying to offset the deflationary impulse of an incredible debt balance and an aging population.

 

Does anyone have any thoughts on what the bond market and the stock market are currently telling investors? In the US long bond yields have been coming down for the last eight months. They certainly seem to be forecasting much lower growth moving forward. The stock market on the other hand is 5% from its highs and seems to see solid economic growth moving forward. The two perspectives do not seem to line up.

 

My view is the bond market tends to give investors better information than the stock market over the short to medium term.

 

Imo this is a common misconception.  Perpetual lower bond yields/growth lead to HIGHER stock multiples. 

 

As Buffett said: "if you had zero interest rates and you knew you were going to have them forever, stocks should trade at 100 or 200 times earnings".

 

Lower interest rates = Higher P/E ratios

 

 

Honestly, I'm so tired of this line being quoted. It has only been true in the U.S. and nowhere else. And the reasons it has been "true" for the U.S. aren't due to the low rates, but rather due to the following:

 

1) Higher relative growth

2) Low and stable inflation

3) Expectations that 1) and 2) will continue into perpetuity

 

Not anything to do with low rates. We haven't seen extremely elevated multiples in Japan who has had incredibly low interest rates for my entire life. We haven't seen extremely elevated multiples in Europe who has interest rates far lower than the U.S. and has for years. Low rates =/= higher equity multiples.

 

Buffett's statement only makes sense if you have assurance rates will remain low forever. When has that ever happened?!?!?! Rates are actually quite a bit more volatile than we give them credit for. (as demonstrated by the 100 bp decline in the 10 year treasury in the last 8 months). And you know who has had low interest rates for majority of most of our lives? Japan. And yet they still haven't even recovered to the highs they hit in the early 90s which set off their low interest rates path....

 

If interest rates fall because growth falters equity multiples will NEVER do well. Never.

Deflationary environments NEVER lead to expanding equity multiples. Never.

 

Growth going down leads to lower interest rates. Inflation turning negative leads to lower interest rates. Neither is supportive of stocks.

 

The ONLY environment where low rates supports stocks is an environment where inflation is low, but positive, and stable. We've been there for nearly 10 years - it seems we might be leaving that arena for one where inflation turns negative. Once again, this is NEVER supportive of equity valuations.

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1. WFC had greater scrutiny a year ago and they were allowed $24.1 billion in buybacks. $24.1 billion is 12% of today's market cap. Their consumer deposits and checking account customers have only gone up over the past year. Apparently, their customers like them even if Elizabeth Warren uses WFC as a theatrical prop.

 

2. Buffett said if he had spent his time trying to figure out when the next recession would happen, Berkshire would be at $15. From my side, I made 40% on my stocks this year by moving from 100% cash to 0% cash in January, after the Fed meeting.

 

I agree there is speculation in tech stocks. FT has prepared a long list of such companies titled "when is the crash?"

https://ftalphaville.ft.com/2019/03/27/1553662858000/The-cloud-software-kings-are-nuts--when-s-the-crash-/

 

But something like WFC is rock-solid. In 4 weeks, they will announce a buyback of 10% of their market cap plus a 4% dividend yield. The US economy is very strong and will stay that way.

 

The rest of the world has never impacted the US economy, simply because the exposure to the rest of the world has always been very small here.

 

wfc will buy back 10% of common stock over the fed's dead bodies

 

1) Agreed. WFC isn't going to buyback anywhere near that amount with the regulation and scrutiny they currently have.

 

2) The idea that the rest of the world has never had an impact on the U.S. and never will is terribly short-sighted. The globe used to be dependent on U.S. economic strength. Now the globe is dependent on credit creation in China. Further, the U.S. is hardly "very strong". As has been pointed out by a few, nominal economic growth has been less than nominal national debt growth in the U.S. for the last several years - i.e. without gov't spending/borrowing trillions more than it had, GDP would have been negative. This is obviously unsustainable and in no way indicative of a "strong" or "self sustaining" economy.

 

And despite trillions in stimulus spending, tax cuts, and QE, we still haven't been able to spur growth above what would've been considered paltry pre-crisis nor have we had any appreciable amount of inflation despite generational low unemployment. Methinks all of these factors are still trying to offset the deflationary impulse of an incredible debt balance and an aging population.

 

Does anyone have any thoughts on what the bond market and the stock market are currently telling investors? In the US long bond yields have been coming down for the last eight months. They certainly seem to be forecasting much lower growth moving forward. The stock market on the other hand is 5% from its highs and seems to see solid economic growth moving forward. The two perspectives do not seem to line up.

 

My view is the bond market tends to give investors better information than the stock market over the short to medium term.

 

Imo this is a common misconception.  Perpetual lower bond yields/growth lead to HIGHER stock multiples. 

 

As Buffett said: "if you had zero interest rates and you knew you were going to have them forever, stocks should trade at 100 or 200 times earnings".

 

Lower interest rates = Higher P/E ratios

 

 

Honestly, I'm so tired of this line being quoted. It has only been true in the U.S. and nowhere else. And the reasons it has been "true" for the U.S. aren't due to the low rates, but rather due to the following:

 

1) Higher relative growth

2) Low and stable inflation

3) Expectations that 1) and 2) will continue into perpetuity

 

Not anything to do with low rates. We haven't seen extremely elevated multiples in Japan who has had incredibly low interest rates for my entire life. We haven't seen extremely elevated multiples in Europe who has interest rates far lower than the U.S. and has for years. Low rates =/= higher equity multiples.

 

Buffett's statement only makes sense if you have assurance rates will remain low forever. When has that ever happened?!?!?! Rates are actually quite a bit more volatile than we give them credit for. (as demonstrated by the 100 bp decline in the 10 year treasury in the last 8 months). And you know who has had low interest rates for majority of most of our lives? Japan. And yet they still haven't even recovered to the highs they hit in the early 90s which set off their low interest rates path....

 

If interest rates fall because growth falters equity multiples will NEVER do well. Never.

Deflationary environments NEVER lead to expanding equity multiples. Never.

 

Growth going down leads to lower interest rates. Inflation turning negative leads to lower interest rates. Neither is supportive of stocks.

 

The ONLY environment where low rates supports stocks is an environment where inflation is low, but positive, and stable. We've been there for nearly 10 years - it seems we might be leaving that arena for one where inflation turns negative. Once again, this is NEVER supportive of equity valuations.

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I meant to add I moved from 100% cash to 0 cash based on the strength of the economy. The US economy continues to be very strong, it has always had minor problems. We can always make a list of negatives about the economy, but as Buffett says the positives rarely get mentioned. Permabears sold a lot of newsletters in 2009, but bulls made the money.

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I meant to add I moved from 100% cash to 0 cash based on the strength of the economy. The US economy continues to be very strong, it has always had minor problems. We can always make a list of negatives about the economy, but as Buffett says the positives rarely get mentioned. Permabears sold a lot of newsletters in 2009, but bulls made the money.

What is RuleNumberTwo again?

https://www.collaborativefund.com/blog/five-lessons-from-history/

"Long-term success in any endeavor requires two tasks: Getting something, and keeping it. Getting rich and staying rich. Getting market share and keeping market share. These things are not only separate tasks, but often require contradictory skills. Getting something often requires risk-taking and confidence. Keeping it often requires room for error and paranoia. Sometimes a person masters both skills – Warren Buffett is a good example. But it’s rare."

 

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My guess is that this has to do with investor demographics.  In the bond market there are the macro trader types who are seeing negative economic indicators and loading up on mid-long term treasuries.  Those guys could be exiting/shorting stocks too but their trades alone are probably not enough to cause a market crash given the corporate buybacks and continued buying by investors who don’t pay much attention to macro. 

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I think bond yields are reflecting inflation expectations as the upside to high growth is par & the downside with inflation is lower real value.  Stocks are more complicated as they are driven by growth expectations and also inflation expectations.  The future changes in each are driven by changes in inflation expectations (bonds) & inflation expectations & earnings growth (stocks).  So a situation with low inflation expectations and declining earnings growth expectation will lead to higher bond prices and flat stocks prices (the lower earnings growth expectations offsetting the lower inflation expectations for stocks).

 

Packer

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I meant to add I moved from 100% cash to 0 cash based on the strength of the economy. The US economy continues to be very strong, it has always had minor problems. We can always make a list of negatives about the economy, but as Buffett says the positives rarely get mentioned. Permabears sold a lot of newsletters in 2009, but bulls made the money.

What is RuleNumberTwo again?

https://www.collaborativefund.com/blog/five-lessons-from-history/

"Long-term success in any endeavor requires two tasks: Getting something, and keeping it. Getting rich and staying rich. Getting market share and keeping market share. These things are not only separate tasks, but often require contradictory skills. Getting something often requires risk-taking and confidence. Keeping it often requires room for error and paranoia. Sometimes a person masters both skills – Warren Buffett is a good example. But it’s rare."

 

Nice  :)

 

“The dead outnumber the living fourteen to one,

and we ignore the accumulated experience of

such a huge majority of mankind at our peril.”

 

---

 

edit:

 

Lesson #2 sounds a lot like Musk.

 

oops, another edit:

 

(should stop commenting as I read)

(the author gets to the parallel to Musk)

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A few months ago some Wall Street analyst pointed out that the US economy is less cyclical than before: more healthcare, less manufacturing. Less subject to inventory accumulation and liquidation. Needs a bigger catalyst to go into recession.

 

Today's unemployment insurance claims data, this is the lowest it has been since the 1960s. Adjusted for the working-population growth, this is even lower than the 1960s.

 

https://www.dol.gov/ui/data.pdf

 

"In the week ending May 25, the advance figure for seasonally adjusted initial claims was 215,000, an increase of 3,000 from

the previous week's revised level. The previous week's level was revised up by 1,000 from 211,000 to 212,000. The 4-week

moving average was 216,750, a decrease of 3,750 from the previous week's revised average. The previous week's average was

revised up by 250 from 220,250 to 220,500. "

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Jim, i agree that generally speaking lower bond yields should support higher PE multiples. Given the abrupt and large move lower in US yields i am wondering if the bond market is forcasting slower global growth moving forward; this will result in lower earnings for companies and usually leads to lower equity prices.

 

I am just surprised at the abrupt pivot in the thinking of bond investors. 12 months ago all the talk was how 10 year yields in the US would be pushing 3.5% and perhaps even 4%). Today we have 10 year rates below 2.3% with some saying they may fall below 2%. I am just trying to understand what is driving the pivot. The stock market looks oblivious to what has been going on in the stock market and i find this interesting.

 

I think in the 20th century you had approximately 2.1% productivity growth + 1.25% population +  3.4% inflation = 6.75% nominal GDP growth.  No surprise that average 10 year yield was in the 5-6% range during the 20th century with an average PE ratio of 15-20

 

Going forward, in the 21st century, i'd guess we see something more like 1.75% productivity growth + 0.5% population growth + 2% inflation = 4.25% nominal GDP growth, in which case bond yields staying consistently below 3.5% doesn't seem abnormal to me.  P/E ratios around 30 wouldn't surprise me in such a low growth environment.

 

Important to note that i'm much more sure about population and productivity numbers going forward.  The 2% inflation guess is simply an educated guess. Political climate could change tomorrow and 4% inflation could be the norm. I'm not great an handicapping politics so take my inflation guess with a grain of salt. Of course we are all forced to guess at the future inflation rate whether we'd like to admit it or not. IMO Buffett is implicitly guessing at a higher inflation rate by holding so much cash.  He very well may be right.

 

I compared a few other metrics in the 20th century vs 21st century.  Very rough approximates and guess, but found the it useful for me.

 

Should note that, as you mentioned, earnings will be lower despite higher P/E ratios.  As you can see in the last row in my table, the overall equity return is lower going forward despite higher average P/E ratios (absolute earnings growth is lower corresponding with lower NGDP growth)

 

http://www.splitrockcap.com/uploads/6/7/6/0/67607749/2018_annual_letter_-_split_rock_capital_management.pdf#page=8

 

 

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Today's unemployment insurance claims data, this is the lowest it has been since the 1960s. Adjusted for the working-population growth, this is even lower than the 1960s.

 

Unemployment is a lagging indicator.  It normally hits the bottom right when the stock market peaks and the economy is about to go into a recession.  So this data point is, if anything, a reason to be cautious.

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While I dont disagree with much of the sentiment, at least on an academic level, what I think is flawed is the notion that equity risk is high relative to future returns. Granted, no one knows the future, but people have been saying this for at least the last half decade and returns have been more than adequate. There is little reason this can not continue to be the case. At least not any more reason than there is to make the case that it can not continue.

Thanks for those comments. An interesting aspect is that while you reject the academic argument, to justify expectations, you basically submit what Myron Scholes brought to the quantitative side of LTCM. Being idiosyncratically stupid in most areas, I've found that, to do well, I have to be ready when genius occasionnaly fails.

...

Imo this is a common misconception.

...

As Buffett said: "if you had zero interest rates and you knew you were going to have them forever, stocks should trade at 100 or 200 times earnings".

 

Lower interest rates = Higher P/E ratios

Some months ago, there was an interesting thread led by meiroy about the Austrian stock market. The 10-year government bonds then were at about 0.46%. Today, it says about 0.12%. Does that mean that I should expect stocks to have tripled or quadrupled? When I visited Austria, they seemed to behave like most people do in most circumstances.

A few months ago some Wall Street analyst pointed out that the US economy is less cyclical than before: more healthcare, less manufacturing. Less subject to inventory accumulation and liquidation. Needs a bigger catalyst to go into recession.

 

Today's unemployment insurance claims data, this is the lowest it has been since the 1960s. Adjusted for the working-population growth, this is even lower than the 1960s.

 

https://www.dol.gov/ui/data.pdf

 

"In the week ending May 25, the advance figure for seasonally adjusted initial claims was 215,000, an increase of 3,000 from

the previous week's revised level. The previous week's level was revised up by 1,000 from 211,000 to 212,000. The 4-week

moving average was 216,750, a decrease of 3,750 from the previous week's revised average. The previous week's average was

revised up by 250 from 220,250 to 220,500. "

Your inputs remind me of the Great Moderation period when one of the other inputs were initial claims.

Nobody knows the future but what I see looking back are cycles and, since 2007-9, most of the subpar "growth" has come from people going back to subpar work. Looking forward, it seems to me that a lot of people will be disappointed and, maybe, that's what long-term bond yields are saying.

https://fred.stlouisfed.org/series/ICSA

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