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Last week, my colleague Brian Sozzi argued that tech stocks had developed a yield problem.
It’s actually worse than that: All stocks have a yield problem. And more than just a yield problem, stocks have a “real” yield problem right now.
Over the last week, investors have become more focused on rising real yields, or those adjusted for inflation.
The yield on 10-year TIPS — Treasury Inflation-Protected Securities — rose north of 2.2% on Monday, the highest since March 2009.
Unlike most Treasury bills, notes, and bonds, which pay a fixed rate of interest off a fixed principal value, the principal of TIPS can fluctuate over time.
As the team at Bespoke Investment Group wrote in an email on Monday, “On paper, higher real yields represent market pricing of higher policy rates relative to inflation, and therefore a stronger economy.”
And while part of the market’s focus on TIPS in recent days can, we think, be attributed to the calendar — there are fewer market catalysts in late August than in, say, mid-May — there is no doubt investors are grappling with the economic story of the summer: a resilient US economy.
As Yahoo Finance’s Josh Schafer reported Monday, economists are now focused on looming upside risks to inflation on account of a strong labor market, rising wages, and consumers that continue to spend.
For the stock market, higher interest rates mean lower stock prices, all else equal. In a note to clients on Sunday evening, Fundstrat’s Tom Lee wrote a clear explanation of how his clients right now see these dynamics weighing on markets.
“Over our many conversations with institutional investors in the past week, the vast majority cite the rise in interest rates as the most concerning for equities. This makes sense. The rise in interest rates means the P/E multiple comes under pressure,” Lee wrote.
“The 50bp rise in the US 10-yr to 4.255% is a 7% hit to P/E … and this is about the hit to S&P 500,” Lee added. “And higher multiple stocks would disproportionately get hit, which explains why FAANG/Tech have been hit harder with Nasdaq 100 down -7%.”
As for what’s driving 10-year rates higher, Lee said clients are “puzzled,” with policy actions in China and Japan, a higher US budget deficit, and Nick Timiraos’s article in The Wall Street Journal this weekend all making an appearance in the “possible reason” camp.
But we think the move in real yields coming alongside an increase in nominal Treasury yields suggests this move is about what’s happening fundamentally in the US economy more than anything else — a longer-term shift away from low interest rates than the market thought.
“The selloff [in Treasuries] has been led by a rise in real yields as traders reassess the probability of a higher neutral rate, in line with some recent research from the New York Federal Reserve, and what that might mean for the longer-term outlook for Fed policy,” John Canavan, lead analyst at Oxford Economics, wrote in a note to clients on Friday.
“While expectations for additional rate hikes this year remain low and steady, there’s been a shift in expectations for future rate cuts.”
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