A worker uses a nail gun while installing trim in a home under construction at a Romanelli and Hughes Building Co. subdivision in Dublin, Ohio, July 9, 2020.
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Bonds, it would seem, are speaking the bulls’ language.
Treasury yields rolled to a four-month high last week, the 10-year note reaching 0.84%, as U.S. economic data continue to arrive generally better than expected and the markets anticipate further fiscal-support worth trillions either sooner or later, under this administration or the next.
Bonds racked up the style points, too, in ways that Wall Street tends to read as signs of better economic growth to come. The spread between five- and 30-year Treasurys hit nearly a four-year high, and corporate debt has traded firm against the rising government rates.
The gust of selling in the Treasury market cleared the way for more cyclical, financial and value stocks to improve relative to the big growth stocks that have been largely in pullback mode since before Labor Day. Bank shares in the S&P 500 last week gained more than 6%, while the small-cap Russell 2000 managed a gain versus about a 2% decline for big momentum stocks as a group.
All this is encouraging as far as it goes, implying investors are gaining comfort with a solid growth trajectory into 2021, perhaps boosted by another fiscal infusion, without new Covid-related restrictions undercutting the recovery.
The ‘reflation’ trade
Still, it’s worth considering other drivers of the backup in yields and related equity reactions.
Fidelity’s head of macro strategy Jurrien Timmer last week notes that Treasury yields have simply been catching up to other indicators of a “reflation” trade that have been working for a while.
The idea here is, assets geared to a global economic quickening have been climbing off their post-Covid lows for months, making the yield rise a belated and grudging follower and not a harbinger of fresh insight about the economy.
Bond folks are also pointing out the yield move coincided with commentary by Federal Reserve officials casting some doubt on any plans for the Fed to shift its buying to longer-dated Treasurys to suppress their yields as the government prepares to ramp up its debt issuance to fund the deficit. And hedging by mortgage-securities holders could have accelerated the bump in yields.
Some technical factors, too, might restrain further lift in yields. The 10-year Treasury yield has just levitated enough to meet its steeply down-sloping 200-day average, a potential friction area for the yield rally on a first approach.
Bank of America noted Friday that the spread between U.S. and German 10-year government yields has grown to multi-month highs. At a time when currency hedges are inexpensive and the dollar weak, this should draw overseas buyers to Treasurys to capture richer yields – and ultimately to cap them
Yields trigger value stock move
Whether the start of a long-running expansion in yields or not, the action in bonds is enabling another attempt by value stocks to narrow their yawning performance gap against growth-company shares.
The Russell 1000 Value index relative to the Russell 1000 Growth measure has gained some traction, and to some eyes, is building a foundation for further comeback.
Still, the prominent spike in this relationship back in June also generated enthusiastic calls that the long-awaited renaissance for value strategies was at hand. The peak of Treasury yields and value relative performance was June 8, days after a surprisingly strong jobs report and at a peak of “reopening the economy” enthusiasm. What followed was a reversal in value, a pullback in the S&P 500 as the Sunbelt Covid-case surge unfolded, a strong bond rally and three months of furious Big Tech growth-stock outperformance.
There is no handy way to determine if this display of reflationary energy in financial markets is another head fake. But it makes sense to stay alert to the possibility.
Meantime, the broad stock market has pulled itself into a neutral, somewhat indecisive condition.
‘Mixed, muddled and inconclusive’
On one hand, the S&P sagged a couple of times last week toward the 3400 area, which traders consider the border between its recent breakout range and the former correction zone. The index finished off half a percent for the week, some 3.5% below its early-September peak.
The broadening out of the tape allowed the index to withstand diminishing hopes of a quick stimulus deal and absorb further pressure from mega-cap Nasdaq stocks without breaking its uptrend. Yet that Nasdaq pressure reflects some fatigue among former leaders. Amazon, Apple, Tesla and Zoom Video, to name just a few, have struggled, while homebuilders, semiconductors and cloud-software have come off the boil.
Stocks of companies reporting results responded without much enthusiasm, even for big upside surprises, a sign investors already assumed good numbers were on the way.
And while this looks like benign ebb-and-flow at the index level, investor sentiment and positioning has not reset much from fairly aggressive postures. This is evident in hedge-fund leverage, rampant speculation in upside call options, individual-investor attitudes and general commentary implying most everyone is looking to catch a post-election rally no matter the outcome.
At the end of last week, Citi strategist Tobias Levkovich wrote, “The backdrop for the equity market is mixed, muddled and inconclusive.” Investors leaning bullish, valuations fairly stout, indexes hard-pressed to rise easily without dominant growth stocks working and the Street attitudes toward the election swinging from intense anxiety in September to confidence that any outcome is market-friendly now.
Last week’s lethargic action could well be the market’s chewing through these issues and creating a chance for both bulls and bears to second-guess their views. For what it’s worth, one of the strongest seasonal stretches of the calendar starts early this coming week, just as industrial and Big Tech earnings bombard the market.
Through it all should come a few more hints of whether the bond market’s upbeat-seeming message is worth heeding.