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Falling Real Yields Key to Stock Market Recovery: What Investors Need to Know

Meet the force behind TINA – a popular trader’s acronym for the concept of “no substitute” for stocks.

The real, or inflation-adjusted, yields on safe-haven government bonds have remained consistently negative despite rising inflation, further fueling demand from avid investors. for stocks and other assets that are considered risky.

This concept is simple. “The lower real yields fall, the better off other assets are compared to bonds,” said Joe Kalish, chief global macro strategist at Ned Davis Research.

And they certainly fell. Real yields on U.S. Treasury Department-protected securities, or TIPS, hit an all-time low of -1.196%, based on data going back to 2003, on Nov. hasn’t gone far above that level since, according to Tradeweb, ending Friday at -1.136%.

This phenomenon, in the face of mounting inflationary pressures, has shown to investors and analysts something puzzling. Kalish has previously dubbed negative real yields “the biggest puzzle in fixed income.”

The strategist put some of those pieces together in a November 16 note, identifying three key drivers behind negative yields:

  • Investors looking for inflation protection have flocked to TIPS. After all, TIPS is the only way for investors to directly protect against inflation, as their principal will automatically adjust to CPI inflation. Of course, the Federal Reserve is also a buyer of Treasuries, helping to keep nominal yields private.

  • At the same time, the Fed has also withdrawn its supply of inflation-protected securities. The central bank holds 22% of the total amount of TIPS owed.

  • The unrelenting demand for Treasuries from foreign buyers is keeping nominal yields up despite rising inflation. Nominal US yields are still higher than bond yields in Europe, UK and Japan. US debt looks more attractive even after currency hedging.

Negative and falling yields inevitably accompany rising stock valuations and strong returns.

In a November 1 note, Lori Calvasina, equity analyst at RBC Capital Markets, looked at the performance of the S&P 500 stock index.
SPX,
-0.14%

since the 2008 financial crisis, track it against real yields.

“On a 3-, 6-, and 12-month basis, stock market returns have been much stronger when real yields are falling and negative than when they are rising and positive,” Calvasina said (see chart below. below).

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Capital Market RBC

“This also helps explain, in our view, why the US stock market has recovered more than some expected late in the day in the face of what feels like a flood of negative news. relentlessly.”

Kalish looked at the futures earnings of companies in the tech-heavy S&P 500 and Nasdaq-100
NDX,
+ 0.55%
,
plot them against the actual yield on 10-year Treasuries. He found that rising spreads resulted in stocks outperforming their previous returns, while falling spreads led to underperformance. Falling real yields widen the spread, while rising real yields narrow it.

The difference in year-to-date gains for the S&P 500 is about 4 percentage points, and nearly 6 percentage points for the Nasdaq-100, he said.

Indeed, the relationship between real yields and tech stocks is particularly strong, Kalish said, and has consolidated since the Fed turned to an easier monetary policy stance in 2019. Technology and Other growth stocks are sensitive to interest rate movements because their valuations are based on expectations of earnings growth and cash flow.

That means tech stocks and growth-oriented names could be particularly vulnerable if real yields start to rise, Kalish said.

On the other hand, indexes of broad-based stocks tend to be positively correlated with real yields — rising and falling together, the analyst noted.

Outside of equities, the inverse relationship between gold and real yields is also prominent, with the yellow metal rising when real yields fall and falling when real yields rise.

“Since the GFC (great financial crisis), it seems that the direction of real yields is what matters for gold,” he said.

And then there’s bitcoin
BTCUSD,
+ 1.16%
,
Kalish noted that it struggled from its late 2017 peak to late 2018 — a period largely accompanied by rising real yields. He found that bitcoin was up 180% year-over-year when real yields were falling from what was still quite respectable but much lower – by some large orders of magnitude – 37% when real yields were rising.

It all speaks to investors’ attention to the Fed and other central banks. The Fed began easing its monthly bond purchases this week, scheduled to shorten its program in June.

Investors have increased bets that the Fed will quickly begin raising their policy rates once the tapering process is complete. The flattening of the yield curve as short-term rates rise faster than longer-term rates in anticipation of Fed action, some investors see as the possibility of a policy mistake, with policy tightening monetary policy causes economic recession.

Kalish thinks the curve is sending a more benign signal, reflecting expectations that the Fed will move in time to rein in inflation. However, there is a danger if the Fed ends up delaying its timetable.

“If the Fed and other central banks raise rates and start pushing real yields higher, that could bring some trouble for some of these other asset classes,” Kalish said.

Investors will analyze the minutes of the Fed’s Nov. 2-3 policy meeting, when they’re released at 2 p.m. ET this Wednesday, a day full of US data that will also include weekly jobless claims, October durable goods orders, personal spending and spending data and other releases ahead of the Thanksgiving break on Thursday, when the US markets will be closed.

Nasdaq Synthesis
COMP,
+ 0.40%

closed at a record 16,057.44 on Friday, up 1.2% for the week. Dow Jones Industrial Average
DJIA,
-0.75%

suffered its second consecutive weekly loss, down 1.4%, while the S&P 500 lost 0.3%. The Dow is down 2.4% from its record close from November 8, while the S&P 500 is down just 0.4% from its record close from Thursday.

https://www.marketwatch.com/story/falling-real-yields-are-a-key-to-the-stock-market-rally-what-investors-need-to-know-11637416226?rss=1&siteid=rss Falling Real Yields Key to Stock Market Recovery: What Investors Need to Know

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