Rising Treasury Yields Seem To Be Stirring Some Unease In Equity Market

Key Takeaways:

After some relative calm on the interest rate front, another jump in the 10-year Treasury yield seems to be pressuring stocks this morning, a day after major indices closed at record highs.

With optimism on the vaccine and a newly inked stimulus package, investors appear to be selling safe-haven Treasuries on optimism about the economic recovery. At the same time, there seem to be concerns that stimulus measures and widespread vaccinations that enable further economic reopening could end up causing a problematic rise in inflation, contributing to the higher yield on the 10-year Treasury.

In a speech last night, President Joe Biden directed states to make all adults eligible for vaccination no later than May 1. Separately, news that Novavax’s (NVAX) vaccine candidate is more than 96% effective against the original COVID-19 strain, seems to also be injecting some optimism into the market about the economic recovery.

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But with rates on the rise, tech and growth shares that are sensitive to interest rates have been pulling back, which means we may see further pressure on the tech-heavy Nasdaq NDAQ +0.2% Composite (COMP). Meanwhile, financial stocks that seem like they may benefit from rising interest rates might be able to finish today on a higher note, if premarket indications hold throughout the day.

It seems that the pressure on the Nasdaq is coming amid a reallocation from tech stocks and into cyclical equities. While such a shift can be unnerving, it’s nothing to panic about. Remember back to when the Russell 2000 (RUT) was a laggard for a while.

As we’ve talked about before, there can be a lot of jawing and volatility before ink gets put to paper to make something final. We saw that with the U.S.-China trade war. And we’ve seen it with each pandemic stimulus package.

With Biden’s signing of the latest round of stimulus on Thursday, the market got to view the done deal, and it seems that investors liked what they saw. The S&P 500 Index (SPX) and Dow Jones Industrial Average ($DJI) closed at records Thursday. The COMP rose more than 2.5% in a catch-up move after its correction. It was also interesting to see the small-cap RUT up more than 2% to close at its own record high.

The RUT’s strong move was perhaps a pretty good indicator of the sentiment of the day as many of the companies in it stand to benefit from a boost to the economy that the stimulus plan might help spark, especially if it helps out consumer spending.

That bump for cyclical stocks also got some aid from a jobless claims report that showed claims fell to their lowest point since November. The 712,000 new claims were down from an upwardly revised 754,000 the prior week and came in below analysts’ expectations for 725,000.

With economically sensitive stocks getting help from the jobless claims and stimulus news, you might expect mega-cap tech-related stocks to not have a great day. Those stocks have been somewhat out of favor recently as investors haven’t felt as much of a need for the relative safety they can offer and rising yields have pressured them.

But on Thursday, those stocks did well as concerns about interest rates continued to ease, with Apple AAPL -0.8% (AAPL) gaining 1.65%, Microsoft MSFT -0.6% (MSFT) up more than 2%, Tesla TSLA -0.8% (TSLA) up more than 4.7%, and Alphabet (GOOGL), Facebook (FB), and Netflix NFLX -1% (NFLX) all up more than 3%. Today looks like a different story as shares of those stocks are trading lower ahead of the open.

This earnings season is definitely winding down, but there are still some pretty high-profile companies opening their books.

For one, homebuilder Lennar LEN -3.4% (LEN) is scheduled to report next week. It could be interesting to see if executives there have anything to say on the recent spike in bond yields and their outlook on interest rates and how that might affect the housing market.

Next week also holds some additional indicators for the housing market, in the form of a housing market index for March, a weekly mortgage applications index, and February housing starts and building permit numbers.

FedEx (FDX) is also reporting earnings next week. FDX is an important barometer of business activity because all sorts of companies use FDX to deliver goods they make. Investors might want to tune in to see how business deliveries have been doing as the pandemic has continued but economic activity has been picking up. Remember, business deliveries tend to be more profitable, so that side is particularly important for FDX.

Investors are also likely to watch for developments in FDX’s e-commerce business. As e-commerce has boomed as more people have shopped at home during the pandemic, shipping and fulfillment services have become more important.

Nike (NKE) is another big bellwether company reporting next week. The athletic shoe and apparel maker has a big footprint in retailing in the United States and abroad, and it has faced declines in physical retail traffic in North America even as it has seen digital sales increase. Nike’s experience is a reminder of how the pandemic has accelerated the trend of more and more retail dollars being spent online.

And speaking of retail barometers, next week holds the February retail sales report. With consumer spending making up a huge chunk of the economy, retail sales numbers tend to be closely watched and have the potential to make a high impact on trading the day they come out.

Another closely watched economic event next week is the Fed’s monthly rate-setting meeting. The central bank isn’t expected to raise rates next week, but investors are likely to still comb its statement and tune into the press conference to try to glean information on policy makers’ thoughts on the inflation situation, especially in light of the recent rise in the 10-year Treasury yield.

CHART OF THE DAY: FEAR AND YIELD: In recent days, market worry has spiked along with the 10-Year … [+]

Growth, Risk, and Inflation: Amid expectations for economic growth and a return to some form of pre-pandemic normalcy, riskier assets like oil, cryptocurrencies, and cyclical equities are experiencing more favor from investors. Last month, the Congressional Budget Office said it expects inflation-adjusted gross domestic product to return to its pre-pandemic level by the middle of the year. And the latest Atlanta Fed GDPNow model has first quarter real GDP rising 8.4% on an annualized basis. Of course, rising economic expectations also usher in worries about inflation and potentially tighter policy from the Federal Reserve.

Strong Narrative: Staying with the inflationary theme, while concerns about rising Treasury yields seem to have abated for the moment, they still seem like they’re at least in the back of investors’ minds. The 30-year auction on Thursday seemed to indicate stability in the bond market, a recent trend that seems to be helping market sentiment, according to FactSet. But Wall Street is “still largely looking for rates to move higher … and pro-cyclical rotation to continue on the longstanding fundamental narrative surrounding massive fiscal and monetary stimulus, vaccine rollout, reopening momentum, strong earnings growth, retail inflows and rebound in corporate buyback activity,” FactSet said Thursday.

Change is Afoot: The tension between economic optimism and inflation worry seems to have ushered the market into a new phase where investors appear to be walking a fine line. That seems to be contributing to fluctuations in demand for big tech stocks that are sensitive to rising interest rates. And while risk assets like cyclical stocks and oil seem to be marching higher, they still have their off days too. So we sometimes get significant pullbacks in the market, but we’re also near record highs. We may be in the early days of this change in market sentiment. It seems like volatility could continue until investors decide that they’ve reallocated enough money into cyclicals and out of big tech companies that some were worried had gotten overpriced.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

I am Chief Market Strategist for TD Ameritrade and began my career as a Chicago Board Options Exchange market maker, trading primarily in the S&P 100 and S&P 500 pits.

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