In a way, this year so far looks like last: The benchmark 10-year Treasury yield has risen by roughly the same amount, just over 0.2 percentage points. However, it looks quite different in most respects: Instead of rewarding rampant speculation, the stock market punished those who bet on trendy stocks.
Here are three ways the market appears to be back to normal after the pandemic turmoil, as well as one possible change in its long-term pattern.
stock prices Not relevant again. The start of January last year was unusual for a rush into low-price stocks, a sign of unconscious betting in the markets. The stock price does not mean anything by itself. They only matter in relation to some measure of earnings or assets, so performance should not be tied to price. But a year ago, the strongest determinant of performance was the raw price, probably due to the influx of new traders who have not yet learned the basics.
This year, the market is back to normal: price and performance have no relationship. This is fine, except for those few who are still betting on the small stocks.
Bubbles stock They return to bad business when monetary conditions tighten. Early last year, speculators bet on trending topics, which ballooned into little bubbles: clean energy, hemp, electric vehicles, cryptocurrencies and SPACs — special-purpose buyouts — as well as memorable stocks like GameStop and AMC Entertainment..
Objective bubbles peaked from January to March and began to deflate, although the foam returned in October (and Tesla held onto its gains better than other electric vehicle stocks).
This year’s high bond yields hit many bubble stocks hard once again, with the Ark Innovation ETF – the most visible expression of bets on unproven new technology – down more than 8%. Companies tracking ETFs listed across SPACs and clean energy stocks are down 5% to 7%, while many electric vehicle companies and suppliers (again, with the exception of Tesla) are taking a hit. All subjects with foam are down more than 40% from last year’s highs.
cheap stock It’s back in fashion – where cheapness means a low valuation, not a low stock price. Last year’s growth stocks outperformed cheap “value” stocks, with the Russell 1000 Growth Index returning 27.6% including dividends versus the value index’s 25.2%. That’s not what to expect in a year when bond yields are soaring: Higher bond yields should hurt growth stocks by making long-term future earnings less attractive, while helping the value of stocks, which benefit from a stronger economy that has led to higher yields.
It’s been successful so far this year, with stocks rising while growth stocks, and tech-heavy Nasdaq stocks down.
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The strength of the correlation between bond yields and growth stocks was quite evident on Monday and Tuesday. When 10-year Treasury yields rose above 1.8% for the first time since January 2020, it triggered a daily 3% sell-off in developing stocks — before Treasury yields started falling and growth stocks ripped apart again.
This pattern could be part of a broader shift to the way stocks behaved before the dot-com bubble of the late 1990s, when high bond yields were generally bad for stocks, and low yields were good.
Back in the 1990s, before that, higher yields were more likely to be an indicator of concern about inflation than stronger real growth, so there was little to do well to offset the pain of higher stock returns, and vice versa. Since 2000, the days of high bond yields have also been good days for stocks, as investors focused on positive news with a stronger economy.
The switch appears in the correlation between stocks and bond yields: the correlation of daily changes between the two was mostly negative until 1997, and later turned strongly positive.
Last year, the relationship flipped again, with the weakest link between the S&P 500 and bond yields since early 2007, shortly before the subprime mortgage crisis began. It’s not clear if last year’s reversal was temporary, or a return to the pre-1997 era, but this year’s high returns are sure to hurt stocks and investors are once again (quite rightly) worried about inflation. If this is a permanent shift in the stock-bond relationship, it makes it difficult to build a low-risk portfolio, because bonds will not provide equivalent gains on days when stocks are low.
Worse, higher yields undermine the argument for ignoring the high valuation of US stocks: they are cheap compared to bonds, the main alternative. If bonds become cheaper – that is, yields go up – stocks become relatively less attractive.
I’m less concerned about the value of the shares, which are much cheaper and should be less affected by higher returns. But the obvious risk this year is that yields are rising, monetary policy is tightening, and growth stocks are sending the overall market down. This is not the kind of return to normal that investors want.
Write to James Mackintosh at [email protected]
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