Daily roundup of research and analysis from The Globe and Mail’s market strategist Scott Barlow
The jump in bond yields and the resulting dangers for equity returns dominate Wall Street research reports as the week begins.
BofA Securities strategist Michael Hartnett was perhaps reaching with the title of his report Bondtrarians at the Gate, but he provided the best way for investors to tell when rising yields will hurt equity returns,
“Bond bear market now one of greatest-of-all-time … since Aug 4th annualized price return from +10-year US govt bonds = -29%, Australia -19% (they do YCC! [yield curve control]), UK -16%, Canada -10%; watch bank stocks “tell” bond rout hurting liquidity & growth expectations”
The accompanying chart (click through to see on social media) shows that as long as bank stocks climb with five-year Treasury yields, everything’s fine. But, when bank stocks start falling as yields rise, this means yields are threatening market liquidity and financial conditions and equities are set to fall.
“@SBarlow_ROB Helpful from Hartnett (BoA): “Yields up & banks up = good, yields up & banks down = bad” – (research excerpt, chart) Twitter
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Goldman Sachs U.S. equity strategist David Kostin also provided useful context for the rise in bond yields,
“Investors ask whether the level of rates is becoming a threat to equity valuations. Our answer is an emphatic “no.”… even after the recent rise in yields, the 300 bp gap between the S&P 500 forward EPS yield of 4.6% and the 10-year US Treasury yield ranks in the 42ndhistorical percentile. Keeping the current P/E constant, the 10-year yield would have to reach 2.1% to bring the yield gap to the historical median of 250 bp. If instead the yield gap remains unchanged, and rates rise to 2.0%, then the P/E multiple would fall by 10% to 20x … the recent change in yields has reached a magnitude that is usually a headwind for stocks.Equities have generated an average return of nearly +1% per month, but the return has averaged -1% during months when nominal rates rose by more than two standard deviations and -5% when real yields rose by that amount … This rotation has also weighed on one of the most spectacular outperformers of the last 12 months: Stocks with negative earnings but strong expected growth. A basket of non-profitable tech stocks (GSXUNPTC) soared by 204% last year and 27% in the first six weeks of 2021 before falling by 15% in last two weeks… Although secular growth stocks may remain the most appealing investments on a long-term horizon, those stocks will underperform more cyclical firms in the short-term if economic acceleration and inflation continue to lift interest rates.”
In short, Mr. Kostin is not concerned with the level of bond yields, but is worried about the speed of the jump.
“@SBarlow_ROB GS’ Kostin also providing good rate context” – (research excerpt) Twitter
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Credit Suisse global strategist Andrew Garthwaite sees 2.0 per cent on the U.S. 10-year Treasury yield as the problem level for equity investors,
“What is problem level for equities? Around 2% for the 10y UST, in our view. Historically, equities have been able to accommodate an average 130bp rise in rates with 170bps seen in 08/09. Higher rates hurt equities via valuation, interest charge, growth and funds flow. We don’t see rising inflation expectations as a problem until the Fed meets its target (probably around core CPI of c2.8%) and historically equities have not de-rated until inflation is above 3%. The key driver of multiples in the past 5 years has been the TIPS yield (prior to that it was not).”
Mr. Garthwaite notes that real estate, utilities and beverage stocks are most at risk from rising yields while banks and autos benefit.
“@SBarlow_ROB Garthwaite: 2% on 10Y Ts is the problem level for equities” – (research excerpt) Twitter
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Newsletter (Friday): “We’re all speculators but there are limits " – Globe Investor
Diversion: “Bulb Bubble Trouble: That Dutch tulip bubble wasn’t so crazy after all” – Slate
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Scott Barlow