An unexpectedly strong U.S. jobs number for July has bolstered the case for investors who believe Treasury yields will head higher over the rest of the year, potentially weighing on an equity rally that has taken stocks to record highs.
Yields on the benchmark U.S. 10-year Treasury, which move inversely to prices, stood at about 1.29% on Friday, their highest level since July 27, after Labor Department data showed the U.S. economy added 943,000 jobs last month. Analysts polled by Reuters forecast payrolls adding 870,000 jobs.
Some investors believe the robust jobs numbers could support the view that the Federal Reserve, faced with rising inflation and strong growth, may need to unwind its ultra-easy monetary policies sooner than expected. Such an outcome could push yields higher while denting growth stocks and other areas of the market.
That view, however, is complicated by worries over rising COVID-19 cases across the U.S. that threaten to weigh on growth and the Fed’s insistence that the current surge in inflation is transitory.
In any event, the data will likely ramp up investor focus on this month’s central bank symposium in Jackson Hole, Wyoming. It also may heighten the stakes for next month’s Fed policy meeting, as investors weigh when the central bank may outline its plans for rolling back monthly asset purchases.
The data “gives markets some sort of direction,” said Simon Harvey, senior FX market analyst at Monex Europe. “It makes the upcoming Jackson Hole event and September’s Fed event live.”
Among the implications of higher yields could be a drag on tech and growth stocks with lofty valuations, as rising interest rates erode the value of longer-term cash flows. Those stocks have rallied since yields began drifting lower in March, helping to lift broader markets. For example, five tech or tech-related names alone - Apple, Microsoft, Amazon , Google parent Alphabet and Facebook - account for over 22% of the weight of the S&P 500.
Higher yields could also boost the appeal of so-called value stocks - shares of banks, energy firms and other economically sensitive companies that hurtled higher earlier in the year but have struggled in the last few months.
The Russell 1000 growth index has climbed about 18% since late March against a roughly 6% rise for its counterpart value index.
Strong economic data that pushes up yields could pave the way for investors to move from growth companies to more economically sensitive cyclicals, said Art Hogan, chief market strategist at National Securities in New York.
Goldman Sachs, BofA Global Research and BlackRock are among firms that have said yields will rise to near 2% by year-end -- an outcome that could be hastened if a strong economy pushes the Federal Reserve to begin unwinding its ultra-easy monetary policies sooner than expected. Others, like HSBC, have called for yields below current levels.
“We think the recovery in long-dated Treasury yields that has taken place over the past week or so is a sign of things to come,” said analysts at Capital Economics in a note published Friday.
“We suspect that growth in the U.S. will be quite strong in the coming quarters, and that the recent surge in inflation there will prove far more persistent than most anticipate,” the firm said.
-- David Randall, Saqib Iqbal Ahmed and Lewis Krauskopf of Reuters
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Stocks to ponder
First National Financial Corp. (FN-T) This company has a relatively defensive business model with stable recurring revenue and offers investors an attractive monthly dividend with a current annualized yield of over 5 per cent. As Jennifer Dowty tell us, recent weakness in the share price may represent a buying opportunity for income investors.
Preformed Line Products Co. (PLPC-Q) This is another stock pick from the value investing students of Dr. George Athanassakos. The company makes cable anchoring, fibre-optic and copper-splice closures and high-speed cross-connect devices. But don’t let that put you to sleep. His students think it’s truly undervalued and the stock recently fell to an attractive entry-level price.
What John Wilson, a manager of the $4.9-billion Mawer Global Small Cap Fund, has been buying and selling
As co-manager of Mawer Investment Management Ltd.’s $4.9-billion Global Small Cap Fund, John Wilson saw some of his stocks take a particularly hard hit during the pandemic-induced market meltdown in the spring of 2020. But what quickly went down in his portfolio has, by and large, bounced back strongly, which Mr. Wilson believes is in part because of the firm’s stock-picking approach. What’s he been buying and selling of late? Brenda Bouw found out.
Yes, bonds still belong in your portfolio, and this is why
For most of the previous cycle, and much of the post-COVID-19 recovery since the lows of March, 2020, there has been a large distaste among investors for maintaining Treasury bond exposure in the asset mix. The argument typically points out the low level of yields, or how stretched valuations are (not that it’s stopped equity investors), or how much more money they can make in the stock market. Just close your eyes and buy the dips. Is investing really that simple? And are concentrated, non-diversifying strategies really the most efficient way to build returns? The answer is no, according to economist David Rosenberg. He explains why.
Stagflation? Recession? Bond market messages puzzle investors
If bond markets are taken at their word, the world post-pandemic will be defined by stagflation, a toxic scenario that appears at odds with the bounceback indicated by robust economic data and record-high equities. The flagging of stagflation - high-inflation coupled with low growth - is puzzling, and according to many investors, not trustworthy. Instead, they say, it is a reflection of how central banks’ grip over bond markets has distorted markets’ signaling power. Yoruk Bahceli of Reuters reports.
Others (for subscribers)
Number Cruncher: Five space stocks with sustainable dividends
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Ask Globe Investor
Question: There are a couple of long-term bonds issued by Canadian banks that pay very high yields, and I’d like your opinion. For example, CIBC Capital Trust Tier 1 Notes – Series B currently yield close to 10 per cent. The notes mature on June 30, 2108, with the earliest call date of June 30, 2039. Locking in such a fantastic yield from a stable and strong Canadian bank seems like a no-brainer. Is there a catch?
Answer: Yup – a big one.
Let’s rewind to when these bonds were issued more than a decade ago.
During the financial crisis of 2008-09, Canadian Imperial Bank of Commerce and other banks needed to shore up their balance sheets. To attract capital from skittish investors, they issued notes with supersized yields. The coupon on the CIBC notes, for example, is a juicy 10.25 per cent.
The new securities were important to the banks, because they qualified as Tier 1 capital. This made them as good as equity when calculating the important Tier 1 Capital Ratio, which the banking regulator uses in determining whether the banks have the financial strength to ride out periods of extreme stress.
However, the status of the notes has since changed. Under the stricter regulatory framework known as Basel III that came in response to the financial crisis, the notes have been gradually phased out as Tier 1 capital and will no longer qualify as of the first quarter of the 2022 fiscal year, which for the banks begins on Nov. 1, 2021.
Rather than continue to pay a 10.25-per-cent coupon on $300-million of bonds that are no longer serving their initial purpose, CIBC would rather redeem them. Notwithstanding the original 2039 call date, CIBC reserved the right to redeem the notes at face value earlier if there was a “regulatory event” that affected the notes’ eligibility as Tier 1 capital.
And that’s exactly what CIBC intends to do. In February, 2020, the bank announced that, subject to regulatory approval, it “currently expects to exercise a regulatory event redemption right in its fiscal 2022 year … meaning that this redemption right could occur as early as November 1, 2021.”
CIBC isn’t alone. Toronto-Dominion Bank has said it also expects to exercise a regulatory event redemption right on its TD Capital Trust IV Notes – Series 2 as early as Nov. 1.
“They’re all going to go. They’re all dead,” James Hymas, president of Hymas Investment Management, said of the capital trust notes. The market has understood this for years, which is why the price of the bonds has gradually fallen.
Moral of the story: If something seems too good to be true, it probably is.
What’s up in the days ahead
Investors should worry about China’s recent crackdown on its stock market superstars. They should worry even more about what the crackdown says about the country’s faltering growth. Ian McGugan delves into the issue this weekend.
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Compiled by Globe Investor Staff