Why Every Trader on Earth is Watching the 10-Year Treasury Now with Nick Colas

The podcast discusses the recent increase in long-term Treasury yields, focusing on the 30-year Treasury. Nick Colas explains that the surge is driven mainly by rising real interest rates, not inflation expectations, which have remained stable for the past 15-16 years at around 1.5-2%. The increase in real rates has turned previous gains from long-term Treasuries into losses due to higher yields. The discussion emphasizes the importance of understanding this dynamic, especially for investors in long-duration bond ETFs like TLT, which have experienced negative compounded returns over the last decade.

Colas outlines four main reasons for the climb in real yields: the unwinding of Fed's past bond purchases, the resilience of the US economy despite shocks and rate hikes, growing federal budget deficits, and increased long-term corporate borrowing by tech giants like Alphabet and Amazon. These factors combine to push real interest rates higher, leading to a more cautious approach to duration management, favoring shorter maturities until economic weakening appears.

The conversation suggests that portfolio durations should be kept short (under five years) until signs of economic slowdown emerge. Longer durations might be appropriate when data indicates weakening growth, which could reduce the risk of rates continuing to rise and stabilize real yields. The discussion also touches on the need for strategic laddering of bonds, rather than extending duration broadly, due to the current environment's volatility and resilience of the US economy.

The hosts analyze the current valuation levels of the S&P 500, noting that despite a year-to-date gain of around 12%, valuations are relatively high with limited room for error. They emphasize that recent gains have been driven almost entirely by upward earnings revisions, with little multiple expansion. Colas presents three potential paths for future market performance: a modest 6-16% rise if earnings continue to grow with stable multiples, a stronger 13-28% if multiple expansion occurs alongside better-than-expected oil prices and resolution of geopolitical tensions, and an optimistic scenario of 24-39% if AI-driven earnings growth accelerates significantly, supported by broader economic and technological developments.

A key theme is the rapid advancement of artificial intelligence, with models like ChatGPT improving dramatically since November 2022. The podcast highlights that the race to achieve artificial general intelligence (AGI) is the primary driver of AI investment. Success in this race could confer immense advantages to the leading platforms, allowing them to dominate and potentially solidify the US's status as a global innovation and reserve currency hub. Conversely, losing this race to China or other countries could diminish the competitive edge of US tech giants and impact economic and geopolitical power.

The discussion notes that the tech sector now constitutes nearly 40% of global indices, functioning like a venture-capital-style investment cycle where most profits are reinvested into innovation rather than shareholder returns. Current market correlations are very low, reflecting a resilient US economy that assumes no recession in the near term. The emphasis is on the importance of staying optimistic about AI-driven growth while being aware of the risks, especially as sector-specific risks and leverage increase among large tech companies.

Colas underscores that the US's leadership in AI innovation is critical for maintaining its economic and strategic dominance. He discusses how the US's approach to innovation, capitalism, and ability to generate wealth through technological advancement distinguishes it from China, which imposes more constraints on corporate profits and market dynamics. The US's capacity to innovate and allow its tech giants to lead will determine whether the US retains its global economic advantage or if China’s models begin to overshadow it.