Stock Bulls Counting on Zero Rates Brush Off Rising Yields
(Bloomberg) -- It’s going to take more than a quarter-point rise in bond yields to knock stock investors out of their euphoria.
That’s the message from the last 20 days in markets, where a steady rise in Treasury rates is doing nothing to derail another huge month for the S&P 500. While speculation has been rife that a back-up in yields is perhaps the only thing that could take a bite out of equity valuations, so far the increases haven’t been big enough for stock bulls to notice.
Longer-dated Treasury yields had their biggest run-up in two months Thursday after Chairman Jerome Powell announced that the central bank will target an average inflation rate of 2%, a target that policy makers have failed to consistently hit. Stock investors, who are sitting on gains of more than 50% since March, focused on their preferred narrative -- that Powell’s remarks essentially codify an intention to keep stimulus flowing, maybe for years.
“Given the S&P 500’s foray (however brief) above 3,500, it’s difficult to argue the spike in rates is troubling investors in the stock market,” wrote BMO Capital Markets Strategist Ian Lyngen in a note Thursday. “Instead, the unifying theme in both asset classes appears to be that of confidence in the Fed’s ability and willingness to make policy accommodation a semi-permanent feature of the U.S. economy.”
Despite Thursday’s bump higher, real interest rates -- which strip out the effects of inflation -- remain deeply negative near -1%, boosting the appeal of equities and other asset classes. While a “self-sustaining economic recovery” could pressure real rates higher, the market’s a good 100 basis points away from that being a concern for stocks, according to David Donabedian.
“What we’ve seen so far on the interest rate front has been perfection for equities. We’ve seen negative real rates, yet at the same time, the nominal yield curve has steepened,” said Donabedian, chief investment officer of CIBC Private Wealth Management. “So all of that is flashing green for growth and what the equity market wants to see.”
Yields on 30-year Treasuries hovered near two-month highs Friday after their biggest sell-off since early June following Powell’s speech at the central bank’s Jackson Hole conference. S&P 500 futures were 0.3% higher before the market open on Friday morning.
Rising Treasury rates in the face of strengthening economic data should buoy stocks as well, given that the rally would likely broaden out into less-loved sectors, according to Principal Global Investors. And should monetary stimulus remain on full-bore -- as the Fed has promised it will -- that also speaks to smooth sailing for stocks.
“If the reason for the upward rise is a stronger economic outlook, equities should still perform well as you’d likely see a rotation from defensives to cyclicals, from growth to value, which would uphold the equity performance,” said Seema Shah, chief strategist at Principal Global Investors. “If the Fed accompanies the improved economic outlook with a reassurance that they will keep policy very loose, then that argues against a sharp spike in yields, and easy financial conditions will support equities.”
Signs of such a rotation were on display Thursday. Beaten-down shares of financial and insurance companies -- which tend to falter in low-rate environments -- led the S&P 500 higher. Meanwhile, duration-sensitive technology stocks were among the day’s biggest laggards, after powering much of 2020’s stock market rebound.
“Higher yields will put pressure on the Nasdaq 100,” said Peter Tchir, head of macro strategy at Academy Securities. “It won’t hurt other sectors and should even help financials.”
Still, there will come a point when Treasury yields rise to a level that forces a re-think of equity valuations, according to Morgan Stanley’s Mike Wilson, whose best-case scenario sees the S&P 500 rising to 3,700 by June 2021. Assuming that the bank’s economic recovery outlook goes according to plan and Congress delivers another round of much-anticipated fiscal stimulus, 10-year yields could test 1.5% next year, he said.
“That would have a dramatic impact on valuations, not just for stocks but all asset categories,” Wilson, Morgan Stanley’s chief U.S. equity strategist, told Bloomberg Television and Radio. “Gold and some of these other assets have really gone up because rates have come down, particularly real rates. And if that dynamic were to change abruptly, then we would see a reset.”
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