Before The Bell
The most recent five-day stretch of trading on Wall Street saw the continued rotation out of high-growth stocks, which performed well in 2020, and into some of the value names that underperformed last year. The main catalyst behind this rotation was the continued spike in Treasury yields. The rate on the 10-year Treasury note, which fell to as low as 0.50% nearly 12 months ago, rallied to 1.75% last Thursday, and the accompanying inflation worries took another bite out of the high-growth stocks in the technology heavy NASDAQ Composite and the small-cap Russell 2000. Recently, the U.S. stock market action has been influenced by what is happening in the Treasury market, and this morning a steadying of bond yields is likely to lead to a partial reversal in last week’s trading trends at the start of the session.
For the week, the Dow Jones Industrial Average, NASDAQ, S&P 500 Index, and Russell 2000 all finished in the red with respective setbacks of 0.5%, 0.8%, 0.8%, and 2.8%. Most of the damage was done during last Thursday’s highly bearish session, when traders were spooked by the aforementioned jump in bond yields and worries about inflation following the conclusion of the Federal Reserve’s monetary policy meeting.
The rising Treasury yields—another round of significant stimulus spending and concerns that the U.S. economy could overheat as it reopens further later this year and pent-up demand for goods and services is realized are fueling the inflation narrative—have prompted the recent selective rotation out of the high-growth stocks and into the value names. The better performers of late are the sectors that were out of favor in 2020, most notably the industrial and energy groups. The renewed interest in value has come at the expense of the high-growth (predominately technology) stocks and the more defensive areas, including healthcare, consumer staples, and utilities. The high-yielding defensive categories have been hurt by the recent spike in Treasury yields. This makes fixed-income instruments more attractive options to those accounts stressing income, hence the reduced interest in the higher-yielding, but more risky, equity groups.
Turning to the week at hand, the focus of Wall Street will likely again be on the Treasury market (see below). With little news on the earnings front, the business beat will draw some attention, with notable reports due on existing and new home sales and personal income and spending. The housing and homebuilding sectors have done well recently, reflected by the strong February-quarter results from Lennar (LEN) last week, but it will be interesting to see if the strong performance is sustainable, especially if interest rates continue to rise. We also will get the final revision on fourth-quarter GDP this week and another reading on continuing jobless claims.
So what is an investor to do in this current environment, where equity market valuations are looking rather stretched? The first thing is to stay heavily weighted in stocks, as the government and central bank continues to flood the financial system with liquidity. This easy money backdrop and the Federal Reserve’s intention of keeping rates low through at least 2023 will continue to provide support for equities even if volatility were to pick up again. (It should be noted that the CBOE Volatility Index (or VIX), also known as the “fear gauge” fell to its lowest coronavirus pandemic level last week.) We would continue to look at some of the stocks in the value sectors, most notably the financial names that would benefit from a rise in Treasury yields. Big banks, notwithstanding some possible profit taking this morning, have done well in recent weeks.
Before the market open, the equity futures point to a mixed start for the U.S. stock market. What we are seeing ahead of the opening is a reversal of some of last week’s trends. Technology stocks are looking to recover some of their recent declines. Conversely, some of the value names, including financial services giants JPMorgan Chase (JPM) and Goldman Sachs (GS), are pointing lower. Futures contracts for the banking stocks, along with some of the industrials and cyclical issues, are trading lower. These equity market moves coincided with steadying government bond yields. Treasury yields are pulling back, with a notable retreat on the long end of the curve this morning. Stay tuned.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
