Equity Swoon Looks Different From 3 Percent Yield Skittishness

(Bloomberg) -- For all the saber rattling over the dreaded 3 percent Treasury yield, don’t overplay the role of bonds as the proximate cause for bearish equity moves.

Sure, U.S. stocks dropped 1.3 percent Tuesday. But look under the surface, and pain actually bypassed bond-proxy stocks -- dividend payers that investors typically dump for higher-yielding debt.

Companies with the highest payouts returned 1 percent yesterday, the fourth-best performing investing style out of the 160 U.S. factors tracked by Bloomberg. Meanwhile, the market’s highest fliers sank lower and investors shied away from more volatile shares -- another indication of indiscriminate selling rather than a bond-driven rotation in equity markets.

Possible catalysts for risk-off trading range from a weak outlook for industry bellwether Caterpillar Inc., extended positioning, slowing growth momentum and short-term inflationary pressures.

As such, 3 percent or not: markets were primed to get spooked, according to Tim Emmott, executive director at Olivetree Financial Ltd. in London.

“The fact that high-yielding, defensive utilities were the best-performing sector in the U.S. last night, in an environment where Treasury 10-year yields are backing up above 3 percent, would suggest that equity mindsets were defensively skewed in the U.S.,” Emmott wrote in a note.

Another case in point: Value stocks, those with cheap book value to price ratios, gained 1.3 percent, the best out of all factors tracked by Bloomberg. As such, the declines don’t reflect a cyclical rotation on rate risk, but principally angst over lofty prices, according to Evercore ISI’s Dennis DeBusschere.

“The more obvious culprit is the very high starting equity valuations, the Fed tightening and strong earnings being discounted,” DeBusschere wrote in a note. “The story is multiple contraction in that context, not the 10-year hitting a magical number that forced a steep decline in stocks.”

Positioning data also suggest a broad-based easing in equity exposures. The most shorted stocks outperformed yesterday, dropping only 0.3 percent, while favored long positions adopted by hedge funds fell 1.8 percent, according to baskets compiled by Goldman Sachs Group Inc.

Fast-money investors typically increase short positions to offset losses in their long books. But Tuesday’s price action suggests managers actually reduced short positions, taking profit across the board, Emmott said.

By the end of last week, data from Credit Suisse Prime Services also show equity long-short managers had the highest net exposure since at least 2010 -- suggesting hedge-fund positions were overextended heading into the selloff.

©2018 Bloomberg L.P.

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