The rate crisis is bullish for the stock markets for those who know the story
(Bloomberg) – The week-long spike in Treasury yields sparked an equity crisis that received a lot of attention. But for a contingent of bulls with history on their side, the story is simple: liquidation of bonds, if any, indicates a still dynamic economic environment that has almost always been great for stocks.
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“It’s a manifestation of the idea that the economy is accelerating,” Art Hogan, chief strategist at National Securities, said by phone. “Rising yields should not derail the bull market, especially if they rise for the right reasons.”
Rates took off about 18 hours after the Federal Reserve signaled it was moving closer to liquidating bond purchases in the era of the pandemic as labor markets continue to tighten and any downturn in effects of the delta variant begins to decrease. Economists polled by Bloomberg still expect gross domestic product to jump 5.9% in 2021 and 4.2% next year. Corporate profits are expected to rise 28% in the third quarter.
Over the past 35 years, growth comparable to that expected in 2022 has never coincided with bad years for stocks. And in all the rolling 12-month periods over the past 30 years where the 10-year yield has climbed 50 basis points or more, stocks have moved higher, said Sebastien Page, multi-asset strategist at T Rowe. Price, earlier this year.
Jim Paulsen, chief investment strategist at Leuthold Group, says the economic backdrop is what is causing bonds to sag, leading to rate hikes that are not as hard on stocks as they could be in markets. slower growing environments.
“A 30 basis point increase on a 6% growing economy with solid double-digit earnings growth, that kind of growth, that kind of fundamental leverage in the economy and businesses can offset many problems for the stock market, ”he said. by telephone.
The liquidation of bonds can be attributed to a rise in so-called real yields, which eliminate inflationary effects and are often considered a proxy indicator of the growth expectations of the bond market. Although still deeply negative, real 10-year rates have climbed nearly 20 basis points so far in September, the biggest monthly increase since February.
“Until now, this rate hike has only been about rising real yields, meaning the 10-year isn’t going up because people are increasingly afraid of higher inflation – it’s going up because the bond market reflects stronger real growth, ”Paulsen said.
After moving sideways for months, 10-year Treasury yields crossed the top of a range that had been holding since mid-July, topping 1.55% at some point this week. The speed of the rise has scared off parts of the stock market, including high-valued tech companies whose future earnings are less valuable when rates rise. Tech’s disproportionate weighting in the S&P 500 pushed the index down for the week.
An argument can also be made that a Fed policy overhaul is behind the surge in yields, a scenario that includes the potential for rate hikes much earlier than expected by the central bank that could derail. expansion. Overnight swap rates now suggest traders expect the Fed to raise borrowing costs as early as September of next year.
But US economic data has improved lately, according to Neil Dutta, head of economics at Renaissance Macro Research. He cites a series of positive surprises for August, including home sales, home construction and business investment. Additionally, he says, consumer spending was strong for much of September. Bureau of Economic Analysis data on payment card transactions shows consumer spending increased 15% for the week ending September 21 compared to the same period before the pandemic.
Others, including Aneta Markowska, chief financial economist at Jefferies, also point to improving trends in Covid. Its proprietary model, which uses inputs, including restaurant reservations and domestic and international flights, has improved in recent days amid a sharp drop in delta cases and expiration of improved unemployment benefits, he said. she writes in a note. This is the start of the third stage of the reopening, she said, which could extend throughout the holiday season and create an acceleration of growth in the New Year.
Even with the climb this month to minus 84 basis points, real 10-year yields are still well below the March high of minus 59 basis points. But it’s the rate of change that could shake risky assets more than the absolute level, said Chris Zaccarelli, chief investment officer at Independent Advisor Alliance.
“I don’t think 1.5% over 10 years is a reason to worry, and you’ve seen this level before, with no issues,” he said.
Over the past year, stocks have tended to perform well on days when 10-year Treasury yields also rose. They also generally won when real rates as well as inflation expectations were up, according to Credit Suisse data compiled by Jonathan Golub and Manish Bangard. That means the recent massive sell-off of higher rates is atypical, Golub said via email.
Financials and energy stocks can benefit the most from this environment, as can companies in the materials and industrial sectors, Hogan said at National Securities.
“Yields for most of this year have been like a beach ball being held underwater – and they’re finally coming out and hitting a level that they should be,” he said. “They’re normalizing and I think that’s an expression of the fact that the economy is doing better, and if the economy is doing better, then cyclical economy-sensitive sectors will probably do better too.”
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