(repeats Thursday’s column without any change in text)
ORLANDO, Fla., Sept. 30 (Businesshala) – Bond yields for stocks and other “risky” assets aren’t always bad news, but the current spike is giving investors reasonable cause for concern as they enter the fourth quarter .
The increase in yields comes against the backdrop of heightened valuations on Wall Street, slowing economic growth and declining consumer sentiment. Volatility, while still muted across most asset classes, has also shown signs of a flicker back to life.
The S&P 500 had its worst month since March last year.
The catalyst and context for this is the Fed’s indication that it will raise interest rates earlier and more aggressively than ever before to rein in inflation. There are indications that, in terms of the Fed preparing to pull the trigger, this time it could be different.
According to Bank of America, markets have now entered the “second stage of interest rate woes” – where higher lending costs no longer reflect a booming economy but doubt the strength of economic activity, growth and asset prices. Sows seeds.
In the first phase, rising yields reflect optimism on the economy and attract inflows into leveraged assets for growth, such as corporate debt, which reduce credit spreads and perpetuate the virtuous cycle.
The second phase is “more frightening” as negative consequences for equity valuations and the economy become apparent, and buyers of stocks and corporate bonds become defensive.
In the third stage, interest rates eventually settle to higher levels and the buyers return. What evidence is there that higher rates are now starting to bite?
In January and February, the 10-year Treasury yield rose 33 basis points every month. During that 66 bps backup in long-term borrowing costs, the S&P 500 rose 6.5%, chalking up several new highs along the way.
A 21 basis-point increase in the 10-year yield during September, however, coincided with a 4.76% decline in the S&P 500, the biggest monthly pullback since March 2020.
Nevertheless, the market is still looking bright. The benchmark index has nearly doubled from its pandemic low in March last year, and valuations are still historically very high.
The S&P 12-month forward price/earnings ratio has eased slightly recently, but is still comfortably above 20 and near peaks before the tech crash two decades ago. Schiller’s true P/E ratio gives an even sharper warning.
Also outside the risk curve, US high-yield “junk” credit spreads are hovering just above 300 basis points, their lowest level since mid-2007.
Many investors will undoubtedly look to maximize annual returns and close the year higher, especially if the recent turbulence subsides in the coming weeks and the US debt limit crisis is resolved, or at least by the end of the year. is pushed towards.
There is certainly a seasonal bias toward a positive fourth quarter. The S&P 500 has risen in seven of the past 40 October-December periods, and recent investor surveys still show a strong preference for equities over bonds.
The market sentiment is still declining.
But as Citi’s Matt King noted, Wall Street’s post-pandemic growth has outpaced economic and corporate profit growth, while credit growth is now shrinking. In his view, the only thing holding stocks up is that they aren’t bonds, whose real yields are still very negative despite the recent spike.
These are ripe conditions for improvement, especially with economic growth showing signs of faltering. Economists are lowering their fourth-quarter GDP estimates, and this week’s data shows US consumer sentiment here has dropped to a seven-month low.
This winter could be extra chilly for the markets. The Delta version is still hanging on to consumers and businesses, and the US politics surrounding COVID is as divisive as ever.
Julie Beale, portfolio manager at Kayne Anderson Rudnick, has warned that with cheap money and implied central bank support for so long, markets may now be more prone to crash diets rather than weight loss plans.
“It’s been a volatile week. People are emotional,” she said.