Selling bonds prompts equity investors to face rising rates

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The rise in yields largely reflects investors’ expectations for a strong economic recovery. However, the collateral damage could include higher borrowing costs for companies, more options for investors who had seen few alternatives to equities, and less favorable valuation models for some hot tech stocks, said investors. investors and analysts.

The benchmark 10-year US Treasury yield on Friday stood at 1.344%, down from just 1.157% five trading sessions earlier and around 0.9% earlier in the year.

The S&P 500 fell 0.7% for the week, largely driven by tech stocks, which, after big gains in recent years, are seen as particularly vulnerable to higher yields. Banks, meanwhile, moved ahead, with investors betting that higher long-term interest rates would make their lending business more profitable.

“The market has wavered a bit,” said Brad McMillan, chief investment officer at Commonwealth Financial Network, an investment advisory and brokerage firm. “The market mainly said hurray, the pandemic is under control and the economy is starting to grow. But now we’re starting to see the consequences in the form of higher rates, and I think the market is dealing with that.”

Stuck near all-time lows for most of last year, yields on Treasuries have climbed in recent months, alongside investors’ expectations for a strong economic recovery, in part thanks to an increase in government-funded spending. by debt.

Last week’s move caught the attention of investors as no specific catalyst was apparent. This raised the prospect that yields could rise more quickly and unpredictably than expected – an outcome that many believed would be more disruptive to other assets like stocks than a slow, orderly rise.

The rise in yields, which results from falling bond prices, often reflects investors’ expectations of faster growth and the accompanying rise in inflation, making interest payments of less valuable bonds. A revival in inflation could also lead the Federal Reserve to raise short-term interest rates, although most investors don’t expect this to happen in the short term. An increase in government borrowing could also boost yields simply by increasing the supply of bonds.

This week, investors will follow the latest developments in Washington, where House Democrats hope to finalize a $ 1.9 trillion stimulus package, as well as figures on consumer spending and earnings from consumer companies like Home. Depot Inc. and Macy’s Inc.

They will also continue to monitor yields on Treasuries, the rise of which can hurt stocks in different ways, investors and analysts say.

As yields rise, borrowing costs for most businesses are also expected to rise, which would reduce profits. Higher yields could also prompt some risk averse investors to sell stocks and switch back to government and corporate bonds, now that they will earn more significant returns.

Finally, many investors use the yield on 10-year treasury bills as the discount rate in formulas to value stocks. All other things being equal, the expected cash flows of businesses are considered less valuable when returns are higher. This could threaten many tech stocks as a large chunk of their profits is expected to rise in the future.

Yields on Treasuries remain extremely low by historical standards, but are not that low relative to stock prices, some say. In recent years, the 12-month forecast earnings yield of global tech companies – their expected earnings per share as a percentage of their stock price – has generally exceeded the yield on 10-year Treasuries by at least 2.5 percentage points. percentage.

But the yield differential has recently fallen below that threshold, a sign that the stock market rebound that was previously justified by ultra-low bond yields “is becoming irrational,” Dhaval Joshi, chief European investment strategist at BCA Research, a company investment research firm based in Montreal. company, wrote in a report last week.

Still, many investors aren’t too worried about rising yields, mostly seeing it as a welcome sign that the economic outlook is improving.

“Our baseline scenario is that the advantages of a higher rate plan outweigh the disadvantages,” said Matt Peron, director of research at Janus Henderson Investors.

Many professional equity investors have already built higher returns into their valuation models, and the largest tech companies typically have earnings that justify their prices, he added.

Even so, rising yields could cause investors to rethink their allocations to different sectors, Mr Peron said.

Its own team began adding exposure in the second half of last year to companies such as certain retail brands and online travel companies which are expected to benefit from an economic recovery and are less vulnerable to the upside. rates.

The impact on equities largely depends on how high and how quickly yields rise, analysts say. A series of analysts predict that the 10-year Treasury yield will reach between 1.5% and 2% by the end of the year, as investors begin to prepare for future Fed rate hikes.

So far, the sudden surge in yields reflects more uncertainty about the future than any tangible change in the economy. Earlier this month, the Labor Department reported that consumer staples prices, excluding the often volatile food and energy categories, were essentially flat over the previous two months.

Yields on Treasuries plummeted at the time, only to begin their last steep climb two days later.

This story was posted from an agency feed with no text editing.

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