Death of a Treasury Bull Market Rocks Faith in Market Winners

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Stocks may be catching a breather in Monday trading, but the aftershocks from the sharpest bond selloff in almost five decades are set to reverberate across investing strategies hitched to the cheap-money era.

Consider the troublesome cross-asset linkages out there. Technology stocks have become ever-more sensitive to U.S. debt, with co-movements turning the most negative since 1999, according to Bank of America Corp.

Volatile currencies from the Mexican peso to Australian dollar have become more vulnerable to Treasury gyrations. Meanwhile, the short-term link between bonds and the S&P 500 have spiked to the most positive since 2016 -- signaling the growing threat of concurrent declines across both assets.

As the U.S. experiment with run-it-hot economics spurs the demise of the long-dated Treasury bull market, strategies tied to the low-rate era look dangerous. And that raises the prospect of fresh selling to come.

Death of a Treasury Bull Market Rocks Faith in Market Winners

“The duration heuristic is the most powerful force in the market at present,” Warren Pies, founder of 3Fourteen Research, wrote in a note. “The pandemic -- and our collective response to it -- has created this situation.”

While the Treasury rout has been taking place for good economic reasons -- juicing trades that ride the business cycle -- some of the biggest market winners of the past year still look vulnerable.

Take Big Tech. While they have not always shown a positive link with bonds, the likes of Facebook Inc. and Netflix Inc. are by nature long-duration trades. When economic growth plunged in the pandemic, investors bought these equities for their promise of long-term profits discounted at record-low rates.

With the U.S. economy expected to expand at the fastest pace since the 1980s while bond yields are on the rise, the sector has become less attractive -- while cyclicals like energy and financials have regained favor.

In fact, U.S. tech stocks are even more vulnerable to higher rates now than during the 2013 Taper Tantrum, when the Federal Reserve signaled a reduction in its asset purchases, BofA strategists led by Andy Pham wrote in a note.

The Nasdaq 100 rose almost 2% in Monday trading as Treasury yields dipped, underscoring the close ties between the two.

Death of a Treasury Bull Market Rocks Faith in Market Winners

All this is a problem for those chasing U.S. large-cap benchmarks where tech is easily the chunkiest sector. It’s also an issue for a classic 60/40 portfolio.

One way of figuring out duration risk in stocks is to invert dividend yields, an indication of how long it would take an investor to recoup their initial investment, other things being equal. By that measure, a portfolio with 60% in the S&P 500 and 40% in Treasuries would have highest duration in some two decades, according to Jeroen Blokland.

“Equity duration has steadily increased over the last decade as the weight of technology stocks, very high duration stocks, has risen to all-time highs,” the Robeco portfolio manager wrote on the asset manager’s website. “As a result, portfolio duration has increased as well, as both bond duration and equity duration have spiked.”

Stock sectors have fluctuated in the past month by more than what is implied by their historical relationship with rates, suggesting the market is pricing in another 15 to 25 basis point gain in 10-year yields, UBS Group AG strategists led by Keith Parker wrote in a note last week.

All this is causing headaches for some of Wall Street’s hottest products.

Cathie Wood’s flagship ETF at Ark Investment Management was one of the best performing funds in the U.S. in 2020. But the ARK Innovation ETF, ticker ARKK, is down 20% from a February peak after being caught up in the fallout of rocketing rates.

Risky Business

Sensitivity to rates has been elevated in credit, too. Duration in the $43.5 billion iShares iBoxx $ Investment Grade Corporate Bond ETF (ticker LQD) climbed to a record 10.3 years later last year, according to data compiled by Bloomberg. It’s fallen to 9.7 years now, with the fund slumping around 6.5% this year amid the Treasury yield surge.

Meanwhile in currency markets, commodity-exposed nations including Mexico, Australia and Canada have been in the line of fire thanks to bonds, according to BofA. “The rate rise has contributed materially to a synchronized, risk-off environment across rates, equities, and FX,” strategists wrote in a Thursday note.

A JPMorgan Chase & Co. index of EM currencies has dropped nearly 3% from a one-year high reached last month.

Morgan Stanley, for its part, is bearish on emerging-market currencies on expectations that few central banks will raise rates fast enough to counteract the effects of rising U.S. yields, strategists led by James Lord wrote.

That would mark a break from the past year, when those exchange rates caught a break from a depreciating dollar as risk appetite recovered.

Death of a Treasury Bull Market Rocks Faith in Market Winners

The silver lining in all this? Investing strategies that ride the business cycle are picking up the slack. A long-short value strategy, for example, is set for its best quarter since 2001, a Bloomberg index shows.

“As long as bond yields are moving higher, value has a chance to perform,” JPMorgan strategists led by Mislav Matejka wrote in a note.

©2021 Bloomberg L.P.

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