Whether it’s heroic resolve or epic naiveté, stock investors are giving no indication that they are troubled by the worst volatility to land on the bond market in a year.
In a week when a spike in Treasury yields pressured prices across the equity spectrum, U.S. exchange-traded funds consistently saw inflows — including $2.7 billion at the height of the carnage on Thursday. All told in February, ETFs sucked in a cool $80 billion, four times the 12-month average, data compiled by Bloomberg show.
BloombergIt’s the same optimism that has underpinned the 70 per cent rally in the S&P 500 over 11 months, the best start for a bull market in nine decades. While the sudden jump in yields erodes one pillar support for stock valuations, bulls are choosing to view it as a sign of economic strength that will boost corporate earnings.
“Investors are looking at the market today and saying, ‘Wow, this is going to come back faster than I thought. I need to position myself accordingly,’” said Wayne Wicker, chief investment officer at Vantagepoint Investment Advisers. “There’s a fear of missing out, of being under-invested.”
The bullish view has recently been tested, including in the last five days, when $1 trillion in value was erased from share prices. As 10-year Treasury yields surged to a 12-month high, favored shares sporting high valuations took another hard hit. The Nasdaq 100 dropped the most since October, while Tesla Inc. and star manager Cathy Wood’s ARK Innovation ETF both suffered their worst week since the bear market last March.
People nevertheless bought the dip, with the S&P 500 reversing a decline of almost 2 per cent on Tuesday. Even during Thursday’s rout, signs of panic were few. Volume in the session was largely in line with the year’s average. The Cboe Volatility Index’s spot price stayed below that of its two-month futures, failing to form an inverted curve that usually signals heightened investor fears.
Bloomberg“We’ve seen for many reasons that people have been trained to buy the dips,” Kim Forrest, chief investment officer of Bokeh Capital Partners, said by phone. “Just about every economist out there thinks the U.S. GDP is going to be 6 per cent or above and that says growth. And yes, there’s some specter of inflation that may bubble up,” but, she said, “people are not afraid of inflation because we haven’t had that horrible really life-changing inflation.”
Despite inflation scares emanating from fixed income, energy and financial shares — companies that are seen among those benefiting the most from an economic rebound — advanced for a fourth week in the latest sign of a deepening reflation trade.
The army of day traders, whose buying force had just started to subside before this week, according to JPMorgan Chase & Co., revived their interest in some of the Reddit-driven meme stocks. GameStop Corp., a poster child of the 2021 retail frenzy, gained 151 per cent this week.
“We would admit to still seeing some pockets of speculative excess out there,” said Leo Grohowski, chief investment officer at BNY Mellon Wealth Management. “When we reach levels of maximum bullishness, that is usually a better time to pare back,” he added. “Market pullbacks like we’ve had this week serve as wake-up calls for investors that buy first and ask questions later.”
Rising yields are threatening one big bull case for equities. A valuation methodology, sometimes called the Fed model that compares corporate profits to bond rates, shows stocks are losing their edge fast. The S&P 500’s earnings yield — how much profits you get relative to share prices — recently sat about 1.7 percentage points above the yield on 10-year Treasuries, the smallest advantage in three years.
But from a fund flow perspective, higher yields driven by economic growth tend to be a good thing for stocks, according to Emily Roland, the co-chief investment strategist for John Hancock Investment Management.
BloombergPast episodes of rising rates have foreshadowed strong equity inflows, according to a study by Deutsche Bank AG strategists including Parag Thatte and Binky Chadha. Since 2008, rate upcycles have coincided with positive fund flows in five of the six instances, with inflows averaging $14 billion a month, the firm’s data shows. That compared with outflows of $8 billion in periods when rates were flat or falling.
“We’ve seen a backup in yields, but the return potential in fixed income is going to be very low after two pretty great years for bonds,” said Roland. “Equities we expect to likely do the heavy lifting in a portfolio this year, and investors may be waking up to that.”
