Control Panel: Rising yields and stocks

Rising bond yields can depress the value of stocks in several ways.

  1. Corporate borrowers have to replace maturing debt with higher-yielding debt, reducing profits.

  2. Consumers have to borrow at higher rates, reducing their discretionary income and reducing purchases.

  3. Rising bond yields increase the value of the U.S. dollar against other currencies, making multinational products less competitive.

  4. As bond yields rise, investors find them more competitive against stocks and may sell stocks to buy bonds.

So what does the data say?…

**As the Fed Raises Interest Rates, and Other Central Banks Don’t, What Will That Mean for U.S. Stocks?**
**A look at similar periods from the past shows investors in U.S. stocks should fare relatively well**

**By Derek Horstmeyer, The Wall Street Journal, April 1, 2022**

**The Federal Reserve’s recent decision to begin raising interest rates stands in contrast to many other central banks around the world, which are keeping their baseline interest rates flat or lowering them. ...**

**The WSJ collected historical interest-rate and stock-return data from around the world going back 40 years....**

**How about for our current interest rate environment — with the U.S. raising its rate and the rest of the world mostly keeping rates flat? On average when this has occurred over the past 40 years, the S&P 500 has delivered an absolute return of 0.45% a month (which amounts to 5.53% over a 12-month period)....** [end quote]

That’s not a raging bull market but it’s better than a drop. Of course, this is the average over 40 years so it’s not really predictive of what will happen now. Also, many of the most vulnerable “growth” stocks (with little or no earnings, no dividends and a long timeline to profit, if ever) have already dropped and may drop further.

The Control Panel is telling a split story.

Stock prices are recovering though they are still below the beginning of 2022. The gloom appears to be lifting. VIX is dropping and bullish percent is higher. The Fear & Greed Index is neutral. The trade is risk-on as stocks and junk bonds are outperforming Treasuries. Gold, silver, copper and USD have stabilized. Oil and natgas continue to rise.

Bonds have a more pessimistic story. The Treasury yield curve has risen rapidly at the short end and is now inverted in places. The 10 Year - 2 Year spread is negative, often a leading indicator of recession arriving in several months. This has happened before every recession since 1980. The recessions never arrive immediately, but after a varying interval after the yield curve turns positive again. (The Fed published a paper saying that this indicator doesn’t add any extra information to the 10 year - 3 month spread but so what – the Fed is messing around with the short rates and this spread is easy to retrieve.)

The Atlanta Fed’s GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2022 is 1.5 percent on April 1. That’s an anemic growth rate compared with 4Q2021.

The March Manufacturing PMI® registered 57.1 percent, a decrease of 1.5 percentage points from the February reading of 58.6 percent. The U.S. manufacturing sector remains in a demand-driven, supply chain-constrained environment. Economic activity in the services sector grew in February for the 21st month in a row — with the Services PMI® registering 56.5 percent.

New hires continued to be very strong. U-1 Unemployment dropped to 3.6%.

Inflation continued to spike.

The Covid epidemic has retreated to the point that most businesses do not require masking. Until the Omicron BA.2 variant hits, it’s back to business as usual. And probably even then, since people are sick of pandemic restrictions.…

The war in Ukraine may be subsiding. (Though it’s hard to say, since Russia is unpredictable.) The price of wheat is spiking since Ukraine’s wheat planting season is in March and the invasion may have largely disrupted it. I have invested a little in Fidelity Global Commodity Stock Fund which is largely oil, gas and food commodities.

The Fed has said that they will raise the short-term fed funds rate until inflation is under control. That will be at least a few more times in 2022. They will also begin to taper their “emergency” QE, beginning in May 2022. That will raise mortgage rates, which are already the highest since 2018 just from Fed jawboning.

The METAR for next week is partly sunny. The stock market appears to be regaining optimism despite the Fed’s plans to raise interest rates.