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The rapid upward movement in bond yields is sending a warning about the stock market – especially growth stocks.
The 10-year benchmark Treasury has risen about 20 basis points since the beginning of the year – 1 basis point is equal to 0.01% – and was at 1.13% on Monday. Still relatively low, income is at the highest level since last March, but income alone is not a problem.
The move may be signaling a period of more volatility for the stock market and the potential for further pressure on FANG and other growth names that helped lift the stock market up last year. Some strategists expect Big Tech and growth stocks to slow their gains this year, as cyclical value and names rise with the prospect that vaccines will lead to an improving economy.
Strategists do not see yields at current levels interrupting stock market gains, but the expectation that rates will continue to rise may make the journey more difficult for stock investors.
“I think the path of least resistance … is still up. … The technicians who support this market are strong, but if you are looking for warning signs, there are some warning signs coming out of the fixed income market. ” said Mohamed El-Erian, chief economic advisor to Allianz.
El-Erian, in an interview with CNBC, said yields have been rising on longer-term bonds, such as 10 and 30-year bonds, but the 2-year yield has remained low, anchored by the Fed’s zero interest rate policy. The 10-year term is widely observed, as it influences mortgages and other loan rates.
“It is going up for the wrong reason, not because of growth, but because of a combination of hesitant buyers and people concerned about inflation, not about reflection,” said El-Erian. “So, if this continues, if you get another 20 basis points in another five or six trading sessions, the yellow will flash much more strongly at that point.”
The 10-year yield was above the psychological 1% level last week, after Democrats won two seats in the Georgia Senate, giving Democrats control of the Senate. This has led to more bond sales, as investors have speculated that President-elect Joe Biden will now be able to carry out his trillion spending plans. More stimulus means more debt and more Treasury issuance to pay for it, a recipe for higher yields. Yields move in opposition to price.
“In the past few weeks, we’ve made the leap to rising rates being neutral, to rising rates being positive, for today, where you can argue that rates rising from here are likely to be an obstacle to stocks, particularly high growth, high P / E stocks “said Julian Emanuel, head of BTIG’s equity and derivatives strategy. Emanuel notes that investors have already begun to shift from high growth to value in recent months.
Emanuel expects the S&P 500 to reach 4,000 by the end of the year, but he also sees the market as entering a new phase of speculation, with both positive and negative volatility.
He said the evidence for the speculative phase is apparent in the way the stock market continued to advance, with the 10-year index moving rapidly above 1%. He also pointed to the fact that the stock did not swing much last week, when a violent crowd took control of the United States Capitol during a session of Congress. Inventories also continued to rise as Covid’s cases increased and deaths reached a new daily record level. The market also ignored a very weak employment report on Friday.
“We are in the most speculative phase of the bullish. The price movement confirms that we are in the most speculative phase of the bullish. This does not mean that you will soon reach the top, but you should be ready for more volatility. We are comfortable with 4,000, but you may see a series of corrections of more than 10% along the way, “said Emanuel.
Strategists say it is even more important for corporate profits to be strong in an environment of rising earnings. Strategists at Goldman Sachs and Morgan Stanley warned on Monday that higher interest rates could limit market gains.
“Higher rates are the wildcard and could start a period of declining stock valuations, making profit revisions even more important than normal for stock performance,” wrote Morgan Stanley strategists.
Goldman strategists said that further fiscal stimulus is expected to lead to higher profits in 2021, but raising rates may limit the rise for stock multiples. The multiple is the price / earnings ratio, and many growth stocks are at very high levels. Amazon, for example, has a P / E of 91. Amazon fell 1.8% on Monday, while other FANG members – Alphabet, Facebook and Netflix – also fell.
“You will have more volatility up and down,” said Emanuel. “You can get a new marginal high here, in the next few days, but in general what you will see is that the market becomes more selective, the higher you go up, and this increases the chances of getting a much more complete and comprehensive correction, led high stocks of multiple growth. “
Dan Suzuki, deputy CIO at Richard Bernstein Advisors, said that the types of stocks that should do better are cyclical or value names, the same types of stocks that are most protected from rising rates.
“Basically, by definition, a high P / E share is also embedding great growth. If you put it in terms of valuation, much of the share’s value is far in the future. That value is far in the future is more sensitive to interest. the more the rates go up, the more you discount the future value ”, he said.