COLUMN-Markets flash amber as they enter ‘2nd stage of lower interest rates’: McGeever
(The views expressed here are those of the author, columnist for Reuters.)
ORLANDO, Fla., Sept. 30 (Reuters) – Rising bond yields aren’t always bad news for stocks and other “riskier” assets, but the current spike worries investors as we enter the fourth quarter.
The rise in yields comes against a backdrop of strained valuations on Wall Street, slowing economic growth and declining consumer confidence. Volatility, while still in a coma across a range of asset classes, has also shown signs of coming back to life.
The S&P 500 just had its worst month since March of last year.
The catalyst and context for this development is the Fed indicating that it will raise interest rates sooner and more aggressively than previously thought to curb inflation. There are signs that, as far as the Fed is preparing to pull the trigger, this time it could be different.
According to Bank of America, markets have now entered the “second stage of lower interest rates” – where higher borrowing costs no longer reflect a dynamic economy but cast doubt on the strength of activity. economic growth and asset prices.
Initially, the rise in yields reflects optimism about the economy and attracts flows to assets leveraged for growth, such as corporate debt, which narrows credit spreads and perpetuates the virtuous circle. .
The second step is “scarier” as the negative consequences for equity valuations and the economy become apparent, and buyers of corporate stocks and bonds become defensive.
In the third stage, interest rates finally stabilize at higher levels and buyers return. What is the evidence to suggest that higher rates are starting to weigh in now?
In January and February, the yield on the 10-year Treasury rose 33 basis points each month. During this 66 basis point save in long-term borrowing costs, the S&P 500 rose 6.5%, registering several new highs along the way.
The 21 basis point rise in the 10-year rate during September, however, coincided with the S&P 500 falling 4.76%, the largest monthly decline since March 2020.
Yet the markets still look sparkling. The core index has nearly doubled from its pandemic low in March of last year, and valuations are still historically very high.
The S&P 12-month futures price-to-earnings ratio has retreated slightly lately, but remains comfortably above 20 and near the highs that preceded the tech crash more than two decades ago. Shiller’s actual P / E ratio sounds an even louder warning.
Further down the risk curve, US high yield “junk” credit spreads hover just above 300 basis points, the narrowest levels since mid-2007.
Many investors will no doubt be looking to maximize annual returns and end the year on a high, especially if the recent turmoil abates in the coming weeks and the US debt ceiling crisis is resolved, or at least postponed towards the end of the year.
There is certainly a seasonal bias towards a positive fourth quarter. The S&P 500 has risen in all of the last 40 periods from October to December, except seven, and recent investor surveys still show a strong preference for stocks over bonds.
The general feeling of the market is still to buy the decline.
But as Citi’s Matt King notes, the post-pandemic surge on Wall Street has significantly outpaced economic and corporate earnings growth, while credit growth is now contracting. According to him, the only thing that holds stocks in place is the fact that they are not bonds, whose real returns are still deeply negative despite the recent spike.
These are ripe conditions for a correction, particularly with economic growth showing signs of slowing down. Economists are lowering their fourth-quarter GDP estimates, and this week’s data showed U.S. consumer confidence is falling to its lowest level in seven months here.
This winter can be very cold for the markets. The Delta variant still looms over consumers and businesses, and US policy around COVID is more divisive than ever.
Julie Biel, portfolio manager at Kayne Anderson Rudnick, warns that after gorging on cheap cash and implicit central bank support for so long, markets may now be prone to crash diet instead of a more thoughtful weight reduction plan.
“It’s been a volatile week. People are emotional, ”she said.
By Jamie McGeever in Orlando, Florida Editing by Matthew Lewis