Traders on the floor of the New York Stock Exchange
Bonds could be volatile in the coming week. If yields rise, it could make it difficult for big tech and other growth stocks to gain ground.
Rising bond yields have challenged growth stocks. Names like Apple, Tesla, and Amazon have lagged as investors move to cyclical groups that do well in an economic recovery. Even so, the S&P 500 and Dow both closed at record highs on Friday while the Nasdaq Composite was lower.
The Nasdaq, home of big tech, is up 3% last week but is down 5.5% last month.
For the coming week, the bond market is likely to be oriented towards the Federal Reserve, which will meet on Tuesday and Wednesday.
The central bank is expected to agree to much better growth. Bond professionals are also watching to see if Fed officials will tweak their interest rate outlook, which now doesn’t include rate hikes through 2023.
“The markets have far too high expectations of what the Fed will do or say,” said Gregory Peters, head of multi-sector and strategy at PGIM Fixed Income. “I think the message will be consistent.”
He said that Fed chairman Jerome Powell likely sounds cautious and likely doesn’t give a timeframe for when the central bank will change its bond purchase program or other policy.
Bond yields, moving against price, have risen due to the improving outlook for the economy.
That trade was evident on the stock market, with the Dow rising 4% to a record 32,778 for the week leading up to Friday. Consumer discretionary, which includes retail, were among the top performers, up 5.7%. This has been compounded by optimism that individuals will spend their $ 1,400 worth of stimulus checks.
Returns were higher on Friday after President Joe Biden said all adults would be eligible for a vaccine by May 1. The yield on 10-year government bonds peaked at 1.642% – its highest level in more than a year.
This is the prime rate to watch as it affects mortgages and other consumer and business loans.
“The economy will be incredibly strong this year – deficit spending, reopening, vaccines,” said PGIM’s Peters.
“It looks like all the numbers will be revised higher for next year,” he said. “So this thing could have sustained growth, and I think there will be pressure on rates going higher.”
Bond yields have risen sharply over the past month. The fast pace of the move has made stocks nervous as investors brace for higher interest rates. The 10-year Treasury yield was 1.16% on February 12th.
Growth versus cyclicals
Last month, energy stocks are up nearly 20%, financial stocks are up 10.2% and industrials are up 7%. The S&P tech sector is down 5.4% last month and communications services, which include Internet names, are up 0.8%.
Higher interest rates are a challenge for technology and other growth stocks because those stocks are expensive and have high price-to-earnings ratios.
“When interest rates are very low, people’s valuations don’t matter,” said Peter Boockvar, chief investment officer at Bleakley Global Advisors.
“When prices are low, there is no penalty,” he said. “When rates go up, people are much more sensitive to valuations, and that’s what we’ve seen here.”
Scott Redler, partner at T3live.com, tracks short term stock market techniques and trades many of the growth stocks. Lately, however, he has sat in many value names and cyclicals.
“The names I’m in – Visa, GM, Ford, Macy’s, 3M. Those were my biggest winners this week,” he said. “It was really hard to make money with Apple, Facebook and Tesla.”
The Nasdaq was hit hardest by the rise in interest rates. Apple was down 0.3% last week but down 10.6% last month. The S&P 500 hit a record high of 3,943, gaining 2.6% last week, but is flat last month, gaining just 0.2%.
“Interest rate volatility could cause another turning point in technology,” said Redler. “Tech hit its reactionary low last week, and this one [past] Week it had an oversold jump. The question is, ‘Was that it?’ “
“Next Wednesday Powell could be the deciding factor,” he said. “Prices have hit higher highs and the technology is a long way from last Friday’s lows. Perhaps the market will be more comfortable.”
Apple’s failure is unusual for the technician. It helped propel market gains last year.
“Look at Apple because it’s a little bit of everything. Apple is growth, technology, retail. If something is going well, it should be Apple,” Redler said.
There are some key data in the coming week, including retail sales in February and industrial production on Tuesday. A 20-year Treasury bill worth $ 24 billion will also take place on Tuesday.
The Fed remains the biggest catalyst for the bond market.
The bond market has been speculating on something the Fed may not discuss after their Wednesday afternoon meeting. In one of its moves to prop up the economy during the pandemic, the Fed allowed banks to hold government bonds without adding them to the bank’s leverage ratio. This strategy allowed institutions to use their balance sheets more flexibly for activities such as lending.
The program expires on March 31st.
“This is basically a big problem because so much treasury supply is coming and going [the rule] Basically, it is very criminal for banks to own treasuries, “said Peters from PGIM.
“The markets are divided over what will happen,” he said. “I think most experts believe that an extension is the way forward. They haven’t heard from the Fed on the matter.”
Peters expects the treasury market to remain volatile.
“I think you will see more volatility in a high-pressure, growth economy with extremely high deficits and an accommodative Fed,” he said. “I think you will see these whipping movements.”
Calendar for the week ahead
8:30 a.m. Empire State Manufacture
4:00 p.m. Treasury International Capital data
Merits: Volkswagen, designer brands, Jabil, Lennar, Coupa Software, CrowdStrike
The Federal Open Markets Committee begins a two-day meeting
8:30 a.m. retail sale
8:30 a.m. import prices
8:30 a.m. Survey among managing directors
9:15 a.m. industrial production
10:00 am business inventories
10:00 am National Association of Home Builders poll
Merits: Cintas, Lands’ End, Five Below, Herman Miller, American outdoor brands
8:30 a.m. Housing construction begins
2 p.m. Fed statement
2:30 p.m. Briefing from Fed Chairman Jerome Powell
Merits: FedEx, Dollar General, Nike, Petco, Accenture, Commercial Metals, Seal Jewelers
8:30 a.m. first claims
10:00 am Philadelphia Fed poll