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The rise in bond yields looks like a killer stock market. The good news for shareholders is that the market as a whole could behave well. The problem lies in the FANG and the other acronym actions that have been the most rising indices.
Treasury yields accelerated their rise, but this was a false increase: mainly due to increased uncertainty, rather than expectations of a stronger economy and higher interest rates. Fortunately for equity investors, the problem, largely controlled by big technology disrupters, is not widespread.
The rise in bond yields was fast and painful. An investor who held 10-year Treasuries this year would have lost 5.8% by the end of last week, even after reinvesting the coupon.
Until last week this was not a problem for the S & P 500. But the most recent rise in bond yields, the strongest in four days since the election of 2016, hurt shares, contrary to what some might think, a stronger economy and higher interest rates.
Instead, bond yields were almost entirely increased by a higher term premium, the additional yield offered at interest rates above the expected interest rates for a 10-year locked-in fund. (In a whim of the post-QE bond market, this term premium is currently negative, but less negative than it was.)
Bond investors are less confident about their situation and therefore require a higher term premium. Inflation is uncertain, anecdotal evidence of bottlenecks and labor shortages, even as reliable data suggests that price increases are well under control. The business cycle is long in the tooth, with a lot of talk about the timing of the next recession. And Federal Reserve Chairman Jerome Powell stressed how the central bank knew nothing about the future.
Indeed, equities have fallen slightly and the fastest growing stocks have fallen sharply. Even Amazon.com was down almost 10% between its late summer high and Monday's low, while glamorous stock
Netflix
lost even more in just four days.
There are three reasons to worry. The first is that the acronym stocks …
Facebook
,
Amazon,
Apple
,
Google's parent
Alphabet
,
Netflix,
Microsoft
and others arranged in FANG, FAAMG, etc., flew too high and will now fall. They were pushed higher by strong fundamentals and helped by low bond yields, which made distant profits attractive in comparison. If the rise in yields has broken their momentum, investors will try to cash their profits on the acronym titles before their disappearance.
The second reason for concern is that if the term premium continues to increase, the actions under acronym should continue to suffer. A simple return of the term premium to its level of three years ago, just before the start of the Fed's rate hike, could raise yields to 10 years at 3.75%; a return to what was considered normal would take it well above 4%. Put future profits at a higher interest rate today, they are worth less, which is more striking to fast-growing companies than the rest of the market because a larger part (in some cases) of their profits is distant.
The third concern is that the stock market already looked unhealthy. Since the beginning of September, small businesses are going through a difficult period and bank shares have fallen sharply. Both suggest a lack of confidence in the economic outlook. The market as a whole has been held back by the performance of a relatively small number of large names in high growth sectors. Therefore, if they stumble, the outlook is bleak.
These are powerful arguments, but I hope that, rather than making a full correction of the market, it will only be a question of exaggerated competitors and some of the worst performers. The gap between cheap "value" shares and expensive growth stocks has been huge this year: on the MSCI indexes, US value stocks had risen only 1.6% at the end of the month. September, while growth stocks grew by 16.5%.
A return to value would be a welcome recognition that the future of the economy does not rest on a handful of companies. The last big example of a rise in the term premium and uncertainty has also yielded satisfactory results for equities: when typing tantrum in 2013, the term premium and yields have risen more and faster than they have. have recently, and US stocks have recovered their losses in a month.
There is no guarantee, and companies are both more indebted and more valued than they were in 2013. But at least it's too early to panic about returns bondholders.
Write to James Mackintosh at [email protected]
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