Stock Market Normality Returns, and It Hurts

- Advertisement -

Three ways the market seems to be returning to normal after the pandemic, as well as a potential turnaround in its long-term pattern

- Advertisement -

share prices Again irrelevant. The beginning of January last year was unusual for a rally in low stock price stocks, indicating unrelenting betting on the markets. The price of a share has no meaning in itself. It only matters with respect to earnings or some measure of asset, so performance should not be tied to prices. But a year ago the strongest determinant of performance was raw price, perhaps due to an influx of new individual traders who hadn’t yet learned the basics.

- Advertisement -

This year, the market has returned to normal: there is no correlation between price and performance. That’s a good thing, except for the few people who still bet on penny stocks.

bubble stock When monetary conditions tighten, they are doing badly. Early last year, speculators placed bets on popular topics that inflated into a mini-bubble: clean energy, cannabis, electric vehicles, crypto and SPAC—special-purpose acquisition companies—as well as meme stocks like GameStop and AMC Entertainment.,

- Advertisement -

Thematic bubbles peaked from January to March and began to deflate, although the foam returned in October (and Tesla held its gains better than other EV stocks).

High bond yields this year have hit many bubble stocks again, with the Arc Innovation ETF—the purest expression of bets on unproven new technology—down more than 8%. ETFs tracking companies listed through SPAC and Clean Energy Shares range from 5% to 7%, while several electric-car companies and suppliers (again, excluding Tesla) have been affected. All foamy themes are down more than 40% from last year’s highs.

cheap stock are back in fashion – where cheap means a low valuation, not a low share price. Growth stocks beat cheaper “value” stocks last year, with the Russell 1000 Growth Index returning 27.6%, which included dividends, compared to 25.2% for the value index. In a year when bond yields should not be expected to rise: Higher bond yields should hurt growth stocks by making them less attractive in the future, while helping value stocks, which benefit from a stronger economy, increase yields. increased.

So far this year it has worked out, however, with value stocks, while growth stocks, as well as the tech-heavy Nasdaq, are down.

The strength of the link between bond yields and growth stocks was on full display on Monday and Tuesday. When 10-year Treasury yields rose above 1.8% for the first time since January of 2020, it prompted an intraday 3% selloff in growth stocks — before Treasury yields began to fall and growth stocks rose again.

This pattern may be part of a wider change in how stocks behaved before the dot-com bubble of the late 1990s, when high bond yields were generally bad for stocks, and low yields were good.

In the 1990s, and earlier, higher returns than strong real growth were more likely to be a sign of concern about inflation, so there was nothing good for stocks to take away the pain of higher returns, and opposite of this. Since 2000, even days with high bond yields have turned out to be good days for stocks, as investors focus on positive news of a stronger economy.

The switch is reflected in the link between stock and bond yields: the correlation of daily changes between the two was mostly negative until 1997, and later turned strongly positive.

Last year, shortly before the subprime mortgage crisis began, the correlation flipped again, with the weakest link between the S&P 500 and bond yields since early 2007. It’s unclear whether last year’s flip was temporary, or a return to the pre-1997 era, but certainly this year’s high yields hurt stocks and investors are again (exactly) worried about inflation. If this is a permanent change in the stock-bond relationship, it becomes harder to build a low-risk portfolio, as bonds will not provide offsetting gains in days of stock falls.

Worse, the high yields undermine the case for ignoring the high valuations of US stocks: that they are cheaper than bonds, the main alternative. If bonds become cheaper – that is, yields rise – then stocks become relatively less attractive.

I’m less concerned about value stocks, which are much cheaper and should be less affected by the higher yield. But the clear risk this year is that yield growth, monetary policy tightening and growth stocks are dragging the overall market down. This is not the kind of return investors want.

Write to James Mackintosh at [email protected]


- Advertisement -

Stay on top - Get the daily news in your inbox

DMCA / Correction Notice

Recent Articles

Related Stories

Stay on top - Get the daily news in your inbox