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The rapid rise in bond yields is a warning to the stock market, especially growth stocks.
The benchmark 10-year Treasury is up about 20 basis points since the beginning of the year – 1 basis point equals 0.01% – and stood at 1.13% Monday. Still relatively low, the yield is the highest since March, but the yield itself is not a problem.
The move could signal a period of more volatility for the stock market and the potential for more pressure on FANG and the other growth names that helped move the stock market higher last year. Some strategists expect those big tech and growth stocks to slow their gains this year as value and cyclical names turn higher on the prospects that vaccinations will lead to an improving economy.
Streets don’t see current-level returns stalling the stock market’s gains, but the expectation that prices will continue to rise could make the ride more bumpy for stock investors.
“I think the path of least resistance … is still underway … The technical support of this market is strong, but if you’re looking for warning signs, there are some warning signs coming out of the fixed income market,” said Mohamed El-Erian, chief economic adviser at Allianz.
El-Erian said in a CNBC interview that yields have risen on longer-term bonds, such as the 10-year and 30-year bonds, but the 2-year interest rate has remained low, anchored by the Fed’s zero interest rate policy. . The 10-year year is watched a lot as it affects mortgages and other loan rates.
“It’s going up for the wrong reason, not growth, but a combination of hesitant buyers and people concerned about inflation, not reflation,” said El-Erian. “So if it stays that way, if you get another 20 basis points in another five or six trading sessions, then the yellow blinks a lot brighter at that point.”
The 10-year yield shot above the psychological level of 1% last week after Democrats won two seats in the Georgia Senate, putting Democrats in control of the Senate. That led to more bond sales as investors speculated that President-elect Joe Biden will now be able to push through his multi-billion dollar plans. More stimulus means more debt and more treasury bills to pay for it, a recipe for higher returns. Yields move opposite to price.
“Over the past few weeks, we’ve made the jump to rising interest rates that are neutral, to rising interest rates that are positive, to today, where you can argue that interest rates rising from here are likely to be a headwind for stocks, especially high growth. , high P / E stocks, ”says Julian Emanuel, head of equities and derivatives strategy at BTIG.” Emanuel notes that investors have already begun to shift from high growth to value in recent months.
Emanuel expects the S&P 500 to hit 4000 by the end of the year, but he also sees the market entering a new phase of speculation with both upside and downside volatility.
He said the evidence of the speculative phase is visible in the way the stock market has continued its march as it quickly rose above 1% for 10 years. He also pointed out that the stock didn’t rattle much last week when a violent mob seized control of the Capitol at a congressional session. Stocks also continued to rise as Covid cases increased and the number of deaths hit a new daily record high. The market also ignored a very weak employment report on Friday.
“We are in the more speculative phase of the rally. The price action confirms that we are in the more speculative phase of the rally. It doesn’t mean you are going to top it anytime soon, but you have to be ready. More Volatility. We’re satisfied with 4,000, but you may see a series of 10% plus corrections along the way, ”said Emanuel.
According to strategists, it is even more important that corporate earnings are strong in an environment of rising returns. Strategists at both Goldman Sachs and Morgan Stanley warned on Monday that higher interest rates could put pressure on market profits.
“Higher prices are the wild card and could begin a period of declining stock valuations, making earnings revisions even more important than usual to stock performance,” Morgan Stanley strategists wrote.
Goldman strategists said more fiscal stimulus should lead to higher profits in 2021, but rising interest rates could limit the benefit of 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% Monday, while other members of FANG – Alphabet, Facebook and Netflix – were also lower.
“You get more volatility up and down,” Emanuel said. “You may get a marginal new high here in the next few days, but overall you will see the market getting more selective the higher you get, and that increases the likelihood that you will see much fuller, more comprehensive correction led by high multiple growth stocks. . “
Dan Suzuki, deputy CIO at Richard Bernstein Advisors, said the type of stocks that should do better are cyclical or value stocks, the same types of stocks that are more shielded from rising prices.
“In fact, a high P / E stock by definition also implies a lot of growth. If you want to put it in valuation terms, a large portion of the stock’s value lies far in the future. interest rates rise the more you discount future value, ”he said.