Morgan Stanley’s Sheets Says Get Ready for Higher Real Yields
(Bloomberg) -- Brace for fresh waves of stock volatility as the world’s biggest bond market adjusts to a post-pandemic era.
Morgan Stanley says 10-year inflation-adjusted U.S. yields -- a big valuation driver for risk assets around the globe -- could jump more than 50 basis points to pre-Covid levels as the economic upturn spurs Federal Reserve rate hikes.
All that means the new-year market backlash against expensive stocks that boomed in the low-rate era threatens to continue in earnest.
“There’s still unfinished business in the market,” Morgan Stanley’s chief cross-asset strategist Andrew Sheets said in an interview. “As monetary policy is shifting, it’s too early to think that the interest rate move is done, or that it’s all priced in. There’s still a lot of room for real yields to move higher.”
This year has kicked off with a wild stock rotation as investors bailed on expensive companies with the tech-heavy Nasdaq 100 dropping 4.5% in the first week. Ten-year real yields reached minus 0.77%, the highest level since April.
Sheets reckons 10-year real rates could reach minus 0.3% in 2022 from minus 0.83% currently. While that’s historically low, it threatens fresh pain for investors in rate-sensitive investing strategies.
“We think that would fall more heavily on growth relative to value. We also think that it would be consistent with a lower overall market multiple,” Sheets said.
Some on Wall Street including JPMorgan Chase & Co.’s Marko Kolanovic have called the market reaction to higher rate expectations “overdone.” But for Sheets, the game-changer is the hawkish Fed minutes in December that opened the door to tightening measures that weren’t on the market’s radar -- suggesting the likes of developing-nation stocks are set to underperform anew.
“There’s a shift in inflation tolerance from the Fed, there could be a shift in the reaction function too,” Sheets said.
For many, Sheets’ warning stands out in a market that’s already priced in three and potentially four rate increases this year -- with dip buyers in growth equities in fighting form.
Benchmark 10-year yields fell in the wake of the reading on consumer prices Wednesday. The report was broadly in line with expectations showing inflation reached 7%, the fastest pace in about four decades. Interest rate futures continued to reflect an 88% probability of a quarter-point rate hike in March.
“We have a below consensus forecast for the S&P. That forecast isn’t because we’re bearish on earnings, it’s because we think the multiple on the S&P will fall as real rates go up,” Sheets concluded.
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