U.S. inflation-adjusted bond yields have jumped this month and, according to Goldman Sachs strategist Ryan Hammond, this makes the current environment a dangerous one for equity investors.
Mr. Hammond estimates that the intra-month move higher in 10-year Treasury yields is a 1.4 standard deviation event. Historically, S&P 500 returns have been below average when yields move between one and two standard deviations, and turn negative when the two standard deviation threshold is met.
A rapid climb in inflation-adjusted yields is particularly ominous for technology and growth stocks. As I’ve written previously, there is an inverse correlation between real yields and the S&P 500 price to earnings ratio.
With real yields deeply mired in negative territory near negative 1 per cent in recent years – indicating that bond investors would lose money annually once inflation was taken into account – more investors allocated funds away from fixed income and into the technology-related growth stocks that currently dominate the benchmark. Lower real yields drove stock prices, and aggregate PE ratios, higher.
The U.S. inflation adjusted 10-year yield, as measured by Treasury Inflation Protected Securities (TIPS), has climbed from -1.09 per cent to -0.87 per cent since September 9th, and this has coincided with a 3.8 per cent month to date drop in the S&P 500. The technology sector got hit harder. The tech-heavy Nasdaq has fallen 4.2 per cent in September.
The process that saw falling real rates supporting rising stock prices is now working in reverse as rising yields are pushing equities lower.
Mr. Hammond emphasized that stock prices were better able to withstand climbing inflation-adjusted yields if accelerating economic growth, which helps profit expansion, was the main driver. Unfortunately that is not the case now. “Today,” writes the strategist, “[U.S] economic growth is decelerating, the FOMC is expected to announce the start of tapering at its November meeting, and our economists have downgraded China’s economic growth forecasts.”
The 10-year can be tracked here at the Federal Reserve Economic Data site, and I recommend that investors do so. After a long period of unprecedentedly low inflation-adjusted yields, further moves higher in yields would pose a substantial risk to stock valuations and prices.
-- Scott Barlow, Globe and Mail market strategist
This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you or you’re reading this on the web, you can sign up for the newsletter and others on our newsletter signup page
Forestry stocks are ignoring correction in lumber prices. And for good reasons
Lumber prices have fallen sharply from record highs set earlier this year. Yet the share prices of leading Canadian forestry companies are still well up for the year, suggesting that investors see a lot to like in cheaper lumber. They might be onto something here. David Berman explains.
China’s power crunch dwarfs Evergrande’s troubles in investors’ eyes
China’s power supply crunch, that has shut factories across the country, may pose a much bigger threat to the economy than the debt crisis at Evergrande Group, prompting investors to shun industries vulnerable to power shortages such as steelmaking and construction. Samuel Shen and Alun John of Reuters report.
How to buy what could be the mutual fund industry’s best bargain
Everyone loves ETFs to pieces, but did you know there’s an almost-as-good investing product that is friendlier to beginners and others who value streamlined simplicity? Rob Carrick tells us about the e-series of index funds from TD Asset Management.
What if inflation is here to stay? Think value stocks
The future should bode very well for value stocks if inflationary pressures persist, according to Professor Dr. George Athanassakos and professional investor Reyer Barel. They outline their case here.
Dethroned cash can still rule in stressful times
With central bank interest rates at historic lows for much of the past decade, most long-term investors have found “cash is trash,” quickly burning a hole in their returns. And yet asset managers have not completely dispensed with some cash under the portfolio floorboards as it still offers flexibility and liquidity to maneuver in choppy waters. Mike Dolan of Reuters explains.
Others (for subscribers)
Are you a financial advisor? Register for Globe Advisor (www.globeadvisor.com) for free daily and weekly newsletters, in-depth industry coverage and analysis, and access to ProStation - a powerful tool to help you manage your clients’’ portfolios.
What’s up in the days ahead
Rob Carrick looks at some online tools of interest to dividend-growth investors.
More Globe Investor coverage
For more Globe Investor stories, follow us on Twitter @globeinvestor
You may also be interested in our Market Update or Carrick on Money newsletters. Explore them on our newsletter signup page.
Compiled by Globe Investor Staff