Spiking borrowing costs weighs on risk sentiment for stocks and other risk assets
Investors may need to start scrutinizing earnings again
Ian Fleming’s James Bond arguably wouldn’t be quite as impressive if there was more than one of him.
Part of the draw in Fleming’s fictional character is that Bond is one man against the odds, who persists.
Now had Bond been part of an entire army of spies, chances are Fleming’s novels or the many movies inspired by his books would scarcely be as popular.
So does it go with actual bonds, U.S. Treasuries to be exact – less is often more.
When investors are looking for safety, they stock up on U.S. Treasuries, driving down their yields (yields fall when bond prices rise).
But as the Biden administration looks set to push through US$1.9 trillion of stimulus, that has the potential to stoke higher levels of inflation, a broad sell-off in U.S. government debt rippled through Wall Street.
And it wasn’t just government bonds that saw selling activity, stocks clocked their first three-day losing streak this year, with yesterday’s declines across a broad swathe of sectors, led by energy, tech and industrials.
There are some who are suggesting the run-up in Treasury yields could pose a headwind for stocks, and a dampening in the momentum.
Despite tepid inflation, U.S. government debt was sold off in recent weeks as Biden inched ever closer to his proposed US$1.9 trillion spending bill that has sparked fears of consumer price inflation, making bonds less attractive by eroding the value of their fixed payments.
And a sell-off in bonds increases the so-called “risk-free rate” of return, which is derived from U.S. Treasuries, reducing the present value of the future cash flow of companies and undermines already heady stock valuations.
In simple terms, if the return on holding safe government bonds goes up, the premium that investors are willing to pay to hold onto risky stocks must come down, so company valuations can’t go any higher purely on market mechanics anymore, earnings growth is required.
And that requires a degree of selectiveness that has hitherto been absent as investors have bet on anything from GameStop (-11.43%) to Tesla (-1.35%) and everything in between.
Though technically a “growth” sector, tech stocks, particularly those of firms that are earning even through the pandemic, should still do well, including the likes of Nvidia (-0.52%), Microsoft (-0.17%), Amazon (+0.59%), Google (-0.60%), Apple (-0.86%), Facebook (-1.53%) and Netflix (-0.57%).