Bond market in turmoil as stocks outperform
While all markets have been volatile recently, the normally “safe” Treasury bond market has been especially volatile, and is giving mixed signals. This means that even in a generally “risk off” backdrop, the normally riskier stock market (S&P 500) has outperformed long-term Treasury bonds by a historically wide margin over the last month.
The US bond market has had a rough time lately. The ICE/BofA Long-Term (10 year+) Treasury Total Return index (i.e., which includes coupon payments and price changes) has fallen 16% from its latest November 2021 peak, and is down 23% from its latest cycle peak in July 2020 (excluding the spike in March 2020). Thus bonds are clearly in a bear market by the unscientific “down 20% or more” rule of thumb. And from a volatility standpoint, bonds are at more extreme readings relative to their normal range than stocks are, based on the VIX (S&P 500 implied volatility) and the MOVE index (Treasury bond implied volatility).
Does Tech reliably lag when yields rise? No
We often hear the narrative that rising long-term bond yields are harmful to valuations of “long duration” Growth stocks, especially the Technology sector that dominates the Growth style. This has been evident in day-to-day swings in the market recently.
While we understand the concept embedded in discounted cash flow models that higher discount rates depress current equity values more when capitalizing earnings that occur further in the future, we have been skeptical that the discount rate effect in most cases is sufficiently large to dominate changes in growth expectations or investor risk tolerances, at least for the Tech sector. In other words, our view has been that an investor’s bigger concerns when evaluating higher-Growth Technology stocks are the future earnings growth rate and the risk involved, not whether Treasury bonds yield 1.5% versus 2%. Changes in growth expectations and investor risk perceptions will typically have much larger effects on stock prices than moderate changes in Treasury yields, especially when interest rates (and real rates in particular) are at such a historically low level.
Growth rebound looks extended, as do long-term bonds
We have heard a number of client questions about the recent rebound in Growth stocks relative to Value (or Cyclical) stocks, so here we review some of the recent price action and one of the key cross-asset drivers.
The first chart below plots the relative performance of the S&P 500 Pure Growth versus Pure Value indices (top section) along with the 14-day RSI technical indicator (bottom section) as a measure of overbought/oversold conditions.
Reviewing current stock vs bond sentiment
Despite what you might hear or read some places, investor surveys do not show an extreme level of optimism toward US stocks. Bullishness on stocks has in fact declined somewhat recently and is not far from long-term average readings.
Sentiment toward bonds, by contrast, has moved quite sharply and is now approaching extreme bearishness by the standards of recent years. This is not too surprising, given that long-term Treasury bond yields have recently risen to their highest levels since COVID hit early last year. The result has been that investors in long-term (20+ year) Treasury bonds have lost about 13% since the end of November and about 18% since the end of July.
Bond market making some noise
The bond market has clearly awoken from what appeared to be a low-volatility Fed-induced slumber for much of last year. Longer-term bond yields in the US and elsewhere have jumped to their highest levels since just before the COVID crisis hit markets early last year (blue line in first chart below). Even after this rise, though, the 10-year Treasury yield remains below even the low points of previous cycles.
Risk on? Not really since early June
In financial markets, it seems like “everything” is going up recently. Stocks, bonds, precious metals, even Bitcoin. Perhaps that should not be surprising given the huge amount of liquidity being produced by global central banks in addition to the fiscal stimulus earlier this year. That tends to have the effect of pushing asset prices up generally.
But when we look at relative returns of some key assets, it looks more like the “risk on” trend has not really gone anywhere since early June. That is, owning the riskier option within various asset classes has not generated excess returns to compensate for that extra risk since the recent peak in risk about June 8th.