One, almost universal fear of equity investors came home to roost last week, as higher bond yields pushed stocks off their lofty perch. Valuations that were elevated by almost any measure were presumed safe as long as interest rates stayed low. As long as bonds offered little competition for stocks, and future earnings could be discounted at unusually favorable rates, ever rising stock prices could be justified. But the complacency embedded in that thinking began to crack two weeks ago, as the yield curve began to shift higher.
On Friday, January 26, the yield on the two-year treasury note jumped higher by five basis points to 2.11 percent, and the ten-year rose four basis points to 2.66 percent, both multi-year highs. Stocks paid little notice, as fourth quarter earnings reports were even better than expected, and tax cuts promised even better growth ahead. The falling dollar made the outlook for multi-nationals even brighter.
But stock investors did begin to take notice as last week’s trading got underway and bond yields kept rising. By week’s end the ten-year note yield had climbed to 2.84 percent, its highest in four years, while the two-year rose to 2.16, its highest in almost ten years. Putting an exclamation point on these moves was the wage component of the January jobs report last Friday, which showed year-over-year growth in average hourly earnings, long the most glaringly absent ingredient in stubbornly low inflation, rising by 2.9 percent, the fastest pace since June, 2009 when the economy was just beginning its recovery. If wages are finally beginning to percolate, inflation will as well, and the Fed may have to become more aggressive, or so the thinking goes. That prospect is unsettling in a market that was just coming around to the likelihood of three rate hikes this year, never mind four.
The jobs report was preceded on Wednesday by the Fed meeting that took a slightly more hawkish turn in Chair Yellen’s last meeting. Also, weighing on investors’ minds is the prospect of rising supply that the bond market will be forced to absorb from a combination of expanding budget deficits and diminished central bank buying. And the debt ceiling remains in limbo amid speculation that the Treasury will exhaust its funding sometime in March.
Investors Looking for Safety as Equities Come Under Pressure
As measured by the S&P 500, stocks came under pressure from the very start of the week, and capped off the move lower by falling 2.1 percent on Friday. For the week, the loss amounted to 3.9 percent, quickly erasing any talk of how many days had passed since the last appreciable decline. And there were few places to hide. The defensive groups fared the best, but every sector declined. Getting the worst of it was energy, which slid 6.5 percent, followed by materials and healthcare, although the latter group came under specific competitive pressures from the announcement of a joint venture by Amazon, JP Morgan and Berkshire Hathaway. Telecom, utilities and financials fared comparatively better while still fighting a losing battle.
Overseas markets did offer some refuge, but only in relative terms as they, too, came under pressure. In local currency terms the MSCI EAFE index slipped 2.1 percent and the MSCI Emerging Markets index fell 2.7 percent. The returns in dollars were modestly worse as the currency stabilized somewhat.
Will the Selloff Continue? All Eyes will be on Bond Yields this Week
Read more here: Higher Bond Yields Test Equity Markets