A roundup of what The Globe and Mail’s market strategist Scott Barlow is reading today on the Web
Warning: I’m going to try and cram a lot of sell-off-related content into this small space.
Market risks – notably rising U.S. bond yields, moderating earnings growth expectations and slowing global economic growth – had been building for weeks, and, as is often the case, equity investors decide to react to them all at once in the past few days.
Citi U.S. equity strategist Tobias Levkovich remains relative sanguine , writing “In some respects, it was surprising that the Street took so long to adjust to the jump from 2.81% in August to 3.23% [ in the ten year bond yield] recently.
Rising yields cause a myriad of problems for equities. They make dividend yields less attractive (relative to risk-free bond yields), for one. Also, because the theoretical worth of any stock is the discounted value of future earnings and dividends, rising yields automatically push equity values lower by increasing the discount rate. The most highly valued stocks are disproportionately affected by changes in the discount rate and this helps explain why the technology sector was the hardest hit Wednesday.
So far markets are just recalibrating for a new higher rate environment, so, even if it’s painful for portfolios, the sell-off is intelligible.
What would worry me, a lot, is if rising rates cause panic selling in fixed income ETFs, like the iShares iBoxx High Yield Corporate Bond ETF (US$13.5-billion market cap), SPDR Bloomberg Barclays High Yield Bond ETF (US$13.0-billion) or iShares 20+ Year Treasury Bond ETF ($US 8.5-billion).
To this point, ETFs have been a near-unmitigated positive for investors, and this should remain the case for the longer term. But the prevalence of ETF investing is a big change in market structure and the results of mass selling have not been fully tested.
In the case of high yield bond ETFs, income-starved investors have pushed spreads – the difference between junk bond yields and government bond yields – to lows where, in my opinion, investors are not being compensated for the extra risk. I have only half kiddingly described the so-called U.S. high yield sector as “return-free risk.” The underlying holdings of the high-yield ETFs are not very liquid (although the ETFs themselves have been), and there are risks of huge jump in corporate bond yields and financing costs.
As a reminder, Credit Suisse strategist Andrew Garthwaite has noted that a widening out of high-yield bond spreads has accurately forecasted the end of eight out of the last nine bull markets.
Mr. Garthwaite also argued in a recent report that U.S. bond yields have significant room to move higher.
“The key dynamic in the market right here. Look at these stocks that hedge funds love, and how much they’ve gotten destroyed in just the last 5 days” – Bloomberg
“That was nuts. Is this the crash?” – FT Alphaville (free with registration)
“@RobinWigg Don’t [buy the dip] says RBC’s Lori Calvasina.” (research excerpt) Twitter
“Traders Say Bad Day Was Overdue in Stocks, Not a Reason to Panic” - Bloomberg
“Biggest bond ETF suffers record withdrawals” – Financial Times (paywall)
“Rattled Wall Street stock investors fret about a correction” – Reuters
“All those BBB rated companies? Maybe they shld be junk>> A $1trn Powder Keg Threatens the Corporate Bond Market “ – Bloomberg
“@lisaabramowicz1 Investors continued to pull money from corporate-debt ETFs overnight, building on one of the worst weeks ever in terms of outflows from these funds. The biggest high-yield bond ETF has seen nearly $3 billion of withdrawals in the past week.” – (table) Twitter
“'The Fed is not going to ride to the rescue here. There is no Powell-put for a 3% decline.'" - Tim Duy’s Fed Watch
Tweet of the Day:
"The example that I'd use is changing the engines of a plane mid-flight. Even if the new engine is a better engine, it's bumpy," said @elerianm. "We're transitioning from a market led by central banks to one where fundamentals dominate."https://t.co/MskJ5T7Zg1— Mike Bird (@Birdyword) October 11, 2018
Diversion: “Americans Strongly Dislike PC Culture” – The Atlantic