Erik Oros examines the February Treasury sell-off, growth-stock valuations, speculative excess, and the competing forces affecting the outlook for bond yields.
From the original report
Selected passages from the original publication. Historical observations reflect the report's publication date, not current market advice.
Over the past week, the structural underpinnings of the nascent, nearly one year old bull market, have come under attack. A violent move higher in long term treasury rates, with the 10-year treasury bond yield rising at one point over 50 basis points in just four weeks, has tested the mettle of the market whose reliance on cheap credit, liquidity, and relative value had propelled indices to all-time highs. Ironically, it has been robust growth expectations for US GDP growth in 2021 that have fueled the unorderly treasury market rout. Higher long term interest rates pose the most acute risk to high-growth stocks where valuations have reached levels not seen since the dot-com era.
Prior to a failed seven-year treasury auction on Thursday February 25, 2021, global bond yields had been moving higher in an orderly fashion. This allowed investors to grapple with these effects incrementally and rotate into the reflationary trades we have oft discussed, financials, value stocks, and commodities. However, violent moves higher in rates as we saw on the 25th call into question the “TINA” narrative which has been the enduring tailwind for equity markets even as nominal rates climbed. The prospect for normalized yields more akin to what we have seen over the past few decades, creates competition for stocks and importantly interrupts the march of multiple expansion that had been the key driver of upward movement in prices.
There are however structural forces that are likely to provide a headwind to a continued march higher in global bond yields. While the inflationary pressures of an accelerating economy, continued fiscal packages, and a reopening of the service economy are acute, the deflationary pressures of technology have been well documented and have likely become more engrained as the pandemic has accelerated focus on such factors. Global bond investors continue to be starved for yield and will welcome a more orderly move higher with increased demand for cheaper credits. It is also possible that continued turbulence could spark central bank intervention. While conventionally, monetary authorities have focused their attention on short term interest rates, which their traditional tools are most well designed to address, unconventional intervention in the long end of the curve is not without precedent.
For educational purposes only; not individualized investment, tax, or legal advice. Investing involves risk, including loss of principal.
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