That’s why stock market investors shouldn’t be afraid of rising interest rates
Wall Street Bull statue in New York’s financial district.
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Rising interest rates can set off alarms in the stock market, but strategists say they are ready, not afraid.
For now, interest rates are rising with the idea that inflation will also rise.
But the alert right now probably looks more like a smoke detector and a burnt-out frying pan than a house on fire.
“It’s less about the absolute level of returns and more about how quickly you have to get there, and at this point we’re not concerned about speed,” said Julian Emanuel, chief equity and derivatives strategist. at BTIG.
The most watched return is the benchmark 10-year cash flow, which affects mortgages and other loans.
It was down to 1.16% on Tuesday, after hitting the key 1.2% level on Monday. At this level, strategists say it would head towards 1.25%, which could start a new break up. At the end of January, the yield, which moves opposite the price, hit a low of 1%.
Bond pros say yields will go up, and they’ll go up for a number of reasons.
One big factor is Covid’s fiscal stimulus, the $ 900 billion approved in December, and the $ 1.9 trillion plan that is currently making its way through Congress.
Better growth is expected with federal money, but it also translates into increased debt and potentially inflation. This is another reason for higher returns.
BTIG’s Emanuel said he would be worried if the 10-year yield started to rise. He expects it to hit 1.7% by the end of the year.
However, if it moved too quickly, stocks could get into a tough spot. For example, a danger zone would be around 1.34% if the 10-year rate hit that level as early as this month.
“It would likely be a stock that caps the market rise and causes a new rotation from high growth multiple stocks to cyclicals and value,” Emanuel said.
“Cyclicals, in particular, could absorb this kind of rotation and keep the market moving sideways,” he added. “The same speculative interest that the public has shown in tech stocks… it’s entirely possible that at some point in 2021, you could get a degree of speculative fervor that you’ve seen in these guys, heading towards them. financial. “
S & P’s financial sector is up about 6% year-to-date.
Banks have grown as the the yield curve steepened. It just means that the difference between short-term rates, like 2 years, and long-term rates, like 10 years, has increased.
This so-called steeper curve helps banks make money because they can borrow at very low short-term rates and lend at a higher rate for longer periods.
Bank of America strategists say energy and tech hardware are among the expensive sectors that could be affected by the rate hike. Banks, diversified financial services and semiconductors are among the cheap sectors benefiting from the rate hike, they added.
But strategists say Treasury yields, while rising, are nowhere near where they rival stocks for investment dollars.
Lori Calvasina, head of US equity strategy at RBC, said there is no 10-year fixed level that is a negative trigger for stocks, but “3% feel it’s there that people used to worry about in the past ”.
Calvasina said she is monitoring the number of S&P 500 companies paying dividends above the 10-year yield. At the start of the year, 63% of S&P 500 companies had dividends above the 10-year yield, and a few weeks later it was 56%.
“If it drops to 20% or 30%, at that level, the market might start to struggle,” she said. If the market isn’t having problems at this point, there are still problems and investors see less return over time.
The rise in rate swaps and inflation is largely the cyclical stock rotation that began in the second half of last year as vaccine news was positive and investors began to hope for a more normal economy. in 2021.
Inflation expectations have increased but remain low.
The 10-year breakeven point, which is a market-based measure of inflation, stood at 2.20% on Tuesday, down from around 2.1% at the start of last week. This means that investors are betting that inflation will average 2.2% over the next 10 years.
RBC’s Calvasina said that as rates rise and inflation expectations rise, investors should stick to reflation trade.
Reflation trading is when investors bet on companies that will do well when the economy improves and reopens. This includes airlines, financials, and industries.
Calvasina has also said she loves the financial sector, but some investors mistakenly believe that some of the stimulus trade is already in place.
Energy may be up more than 15% with the rise in oil prices this year, but other cyclical sectors, like materials and industrials, have only risen around 2% since. early 2021.
The growth areas in technology and communications services could be used as a source of funding for the rotation, as they have performed well, Calvasina said.
“As inflation expectations rise, you tend to see the underperformance of technology, the underperformance of communications services. The parts that tend to do well are commodities and financials,” she added.
Jonathan Golub, chief U.S. equities strategist at Credit Suisse, said he didn’t expect technology to be too affected by the rate hike. But the stocks to buy in this environment are among the most junkies.
“I don’t think technology will be stifled. I think the best way to look at it is to find out who earns the most from an improving economy. The answer is cyclical businesses… and businesses that have a business problem. “, did he declare. . “You want someone who’s on the precipice, with smaller cap, companies with a lot of debt.”
Golub also said that the rise in Treasury yields is also positive for the market, as they represent an improving economy.
“The most stimulating event in the history of the planet will not be the end of the First World War, the end of the Second World War, it will be the reopening of the economy this summer,” he said. declared.