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Albert Edwards, a strategist known for his rising opinions, says that even bond yields at current levels could be enough to break a bubble in stocks.
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Interest rates took off last week as investors became more confident of an economic recovery. One problem: stocks can be ill-prepared for growth.
The 10-year Treasury debt yield rose to 1.1% on Friday from 0.91% by the end of the month. Once Democrats gain control of the Senate, the likelihood of Congress approving spending at least a few hundred billion dollars more to support the economy has increased. This means that better growth and slightly higher inflation could occur. Bond yields reflect these expectations.
“It simply came to our notice then [rates] I’m spike is waiting for the stimulus, “said JJ Kinahan, chief market strategist at TD Ameritrade Barron’s. “Are we heading for an inflationary scenario?”
A gradual upward movement in interest rates is generally seen as a sign of optimism, but a sharp rise in yields – or one that the market is not yet priced to reflect – could become problematic for equities. Higher interest rates put pressure on stock valuations as they erode the value of companies’ future profits.
And valuations are high at the moment, reflecting how low interest rates have fallen in historical terms. Shares in the S&P 500 are on average slightly lower than 23 times the expected earnings for next year, well above the long-term average of about 15 times.
“Even 10-year US bond yields now at just over 1% could be enough to reach that peak where the stock market bubble bursts,” wrote Albert Edwards, global strategist at
General society.
The Federal Reserve is investing money in the bond market to keep prices high and interest rates low to boost the economy, but Edwards, who is known for his perennial views, said the Fed itself could not stop the bleeding.
Even with rising yields, investors have paid an increasing price for shares.
S&P 500
ended Friday at 3.3% from Monday’s close.
The assessments, although widespread according to some, are undoubtedly at levels of nasal bleeding. At current prices, the risk premium for the S&P 500’s equity – gains on the index’s average stock outweighs what investors could gain from securitizing 10-year treasury debt – is 3.27%. The first is often above 3%, suggesting that evaluations are not out of control.
At the same time, however, it rarely falls below 3%, and when it does, stocks often fall. Edwards says in his report that the data suggests that bond yields will rise. If earnings from shares did not increase properly, this would mean a lower risk premium.
He said 10-year treasury debt yields tend to rise and fall with movements in the Institute for Procurement Management, the Procurement Manager’s Index or PMI, for production. And this measure has recently reached around 60, the highest level since 1995. This should correlate with a 1.2 percentage point increase in yield over 10 years.
If rates were to rise so fast, without the gains from the gains that a higher PMI and a stronger economy would normally bring, stock valuations would fall.
Viewing rates.
Write to Jacob Sonenshine at [email protected]