Higher Bond Yields Test Equity Markets
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
Whether last week’s losses steepen depends in large measure on where bond yields go from here. A further rise to 3.0 percent or higher will undoubtedly cause further anxiety, especially if it happens quickly. On the other hand, should yields stabilize where they are, the selling pressure in equities may be relatively contained. The underlying fundamentals remain strong. In addition to solid job growth, last week’s reports showed healthy consumer spending and confidence, and robust manufacturing activity. Earnings continued to exceed expectations, and investment grade credit spreads narrowed, although high yield spreads widened slightly. Overseas data from the Eurozone, Japan, and China was solid as well. In the short run, that may matter little if investors decide to take profits and ask questions later. Indeed, as this week gets underway, markets in both Asia and Europe are selling off, and U.S. futures are pointing lower.
On the policy front, the focus once again will be on the ongoing exercise of whether or not the government will remain open beyond Friday. The chances of yet another short-term funding extension are high. Not exactly the confidence inducing outcome that already jittery investors hope to see.
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S&P 500 Index: Is an unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
Morgan Stanley Capital International EAFE Index (MSCI EAFE), an unmanaged index, is compiled from a composite of securities markets of Europe, Australasia and the Far East.
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
Indexes are unmanaged and are not available for direct investment.
The information and opinions in this article are compiled from third party sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Ameriprise Financial. The information is not intended to be used as the sole basis for investment decisions, nor should it be construed as advice designed to meet the particular needs of an individual investor.
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- Chief Market Strategist, Ameriprise Financial
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