Soaring bond rates threaten to muzzle buyers of falling stocks

(Bloomberg) – A valuation case that fueled a near-tripling of the Nasdaq 100 index is under increasing pressure, with soaring interest rates threatening to weaken the no-money argument. alternative actions.

While the picture of bond valuation still leans toward equities from a longer-term historical perspective, it is currently clouded by the largest weekly rise in 10-year Treasury yields in a year. Their push reduced the profit return advantage of the technology-intensive index over the benchmark rate to the lowest level in more than three years.

The Differential, a version of a model called the Fed Model that is the subject of significant analytical controversy, at least gives some insight into the movement of valuations in two markets whose relationship defies easy quantification. Simply put, the more bonds sell, the higher their payouts are relative to the cash flow generated by big tech companies. This potentially complicates the downward buying reflex that has characterized stock markets for more than a decade.

“For years, markets have placed sky-high multiples on growth stocks because there was no alternative. Apparently overnight it looks like there will be plenty of alternatives by the end of the year, ”said Michael O’Rourke, chief market strategist at JonesTrading. “It will be difficult to identify at what levels high-growth names stabilize in an environment where the Fed is raising rates and reducing its balance sheet. The “alternatives” that are resurfacing offer a greater degree of stability. “

10-year T-bill rates hit 1.8% this week – levels not seen since last March – following a bond selloff that shifted into high gear following the release of the surprisingly hawkish minutes of the meeting. December from the Federal Reserve. The surge in yields has hit both speculative assets and the cash-generating tech giants. A basket of unprofitable tech stocks plunged 10% this week, while the Nasdaq 100 fell 4.5% in its worst week since February.

As a result, earnings yields on the Nasdaq 100 – a measure of earnings relative to stock prices – were reduced to 0.85 percentage points above the 10-year Treasury rate, the smallest advantage since October 2018. And it happened quickly. At the start of 2021, there were 83 companies on the Nasdaq 100 with corporate earnings higher than the 10-year Treasury yield, according to data compiled by Bloomberg. As of Friday, that number had risen to 64 companies.

The relentlessness of investors to raise yields is further fueled by the fact that it is driven by real rates, not inflation. This means that the prospect of an economic acceleration has prompted bond traders to raise their rate expectations. While this is not bad news for all equity investors, it is a worrying signal for tech stocks, whose promises of faster growth had drawn investors in over the past decade during an economic period. gloomy.

While all of this has been stirred, there are signs that the ubiquitous dip buyers have tried unsuccessfully to grab the falling knife. Nearly $ 18 billion poured into equity-focused exchange-traded funds over the past week, according to data compiled by Bloomberg. Yet the $ 208 billion Invesco QQQ Trust Series 1 ETF (ticker QQQ), which tracks the Nasdaq 100, was on track to lose nearly $ 700 million.

The question looming in investors’ minds is: Can tech earnings withstand yet another rate shock if the 10-year Treasury yield were to hit 2%, as many are now predicting? Although not an exact science, a simple mathematical exercise shows that the profits of the Nasdaq 100 companies would have to increase by 9% for the price of the benchmark index to stay where it is and maintain its price. current valuation relationship with bonds.

This could be a significant hurdle to overcome. Analysts expect software and internet companies to post a 5.9% increase in profits in 2022, according to data compiled by Bloomberg Intelligence.

Even still, Ally’s Lindsey Bell isn’t too agitated. The Fed’s hike cycle, although it may be starting faster than previously thought, is only expected to take the fed funds rate to 1.75% by 2025. This is not Hardly a level that would kill the equity rally or seriously threaten high valuations, she said.

“Interest rates are always going to be extremely low and they won’t even peak in the last cycle when the Fed hiked rates, and we’ve seen that technology, stocks may have performed well in this environment,” he said. said Bell, Ally’s chief money and markets strategist. “At the end of the day, once the Fed gets through its cycle, because interest rates won’t go to the moon, I think stocks will always be a good place to be.”

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