Bond traders are calling the shots

Stocks were slammed yesterday as Treasury bond yields continued their ascent. The New York Fed reported that while the forward outlook was stable, the current situation for economic activity in the region remains…uncertain.

When the levee breaks.  That sure is a colorful tagline. Even if you don’t know the title from that famed 1971 Led Zeppelin song or the original 1929 blues song by Memphis Minnie and Kansas Joe McCoy, you would certainly have gotten that feeling if you watched the capital markets since the turn of the year. The original song was written to describe the devastating Great Mississippi Flood of 1927. Thankfully, I have no floods in the market to report to you, but there are some interesting developments to note which should help us better understand what is going on.

Stocks have been under the spell of bond yields for some time now. Once it got out that higher yields diminish the theoretical value of stocks, equity traders, most of whom don’t even know the equation for discounting cash flows, have been using rising rates as an excuse to sell their growth stocks. No matter what the reason, growth stocks experienced some explosive growth last year causing them to be somewhat pricey. A cooling off of pedal-to-the-metal growth, therefore, should not have come as a surprise. Being that bond yields are on the brain of most of us these days, let’s take a quick look at them. 

10-year Treasury yields have risen by some +33 basis points since the start of the year. That is a sharp rise for such a short period of time. The conventional wisdom points to a few principal causes. The first is that it is pretty obvious by now that the Fed is going to raise interest rates this year, and 10-year yields are simply responding.  Loose, but conventional. The Fed is also slowing down purchases of bonds and possibly even going to sell them later this year. That would certainly put pressure on bonds, pushing yields higher. A bit less loose and, also conventional. Aside from the Fed, it is clear that we are experiencing significant inflation. Never mind the cause, inflation is here.  Bonds, which pay fixed coupons are very sensitive to inflation.The fixed payments that bondholders receive are worth less as the cost of goods goes higher. Therefore, bond investors need higher yields to compensate for inflation. Conventional, a bit obscure to most investors, but completely factual. 

You are probably aware of those 3 aforementioned drivers as a cause for the recent spike in bond yields. Now, for something less conventional. If you look at a price chart of the 10-year Treasury yields, you will notice some patterns. Check out chart 18 in my attached chart-book. You will see that yields made a run at 1.75% in Aprill of 2021 only to pull back and ultimately recede to below 1.20%. Later in 2021 yields rose again but that time they could only reach roughly to the 1.70% level, a Fibonacci line and a round number, which ultimately became a resistance line. Yields pulled back from that resistance, bounced off a Fibonacci support line at 1.45% then made a second run for that 1.70% resistance line. The second attempt in late November quickly failed and yields retreated to yet a lower Fibonacci support line at 1.35%.  The OMICRON-variant was surging, and traders began to anticipate economic trouble. That fear didn’t last long, and yields made another run for the 1.70% line and breeched it. Once through, yields headed for 1.80%, a natural resistance line.  When treasuries began to trade late Monday night after being closed for the holiday, they opened just above 1.80% and by the time I first checked on them, WHILE YOU SLEPT, 10-year yields were already at 1.84%. At that point it would be up to US traders to render the final judgement after traders in Tokyo and London cast their ballots. 2-year Treasury note yields, more directly tied to Fed policy, were significantly higher as well and served as affirmation. The stronghold 1.80% had indeed, been breached. The last time 10-year yields were at these levels was in January 2020, just before the start of the pandemic. In fact, 10-year notes traded roughly around these very yields, never punching through the 2% level since the Fed began lowering rates in July of 2019. Do you want to give a guess at what the next target for Treasury traders will be?

MOVERS N’ SHAKERS

US Bancorp (USB) shares are lower by -4.6% in the pre-market after reporting misses on both EPS and Revenues by -2.57% and -1.07% respectively. The bank reported that it had lowered its provision for loan losses which accounted for its earnings growth. Further the company reported that it had earned Net Interest Income of $3.12 billion which was lower than the prior year as well as lower than analysts’ estimates. Dividend yield: 2.96%.  Potential average analyst target upside: +7.0%.

Fastenal Co (FAST) shares are higher by +1.49% on pre-market trade after it announced that it beat EPS estimates by +6.87% and Revenue expectations by +1.93%. The Industrial manufacturer has a forward P/E of 33.60, which is higher than the 19.94 mean forward P/E of its peer group, which can be interpreted as the stock being expensive. Dividend yield: 2.13%. Potential average analyst target upside: -7.6%. WHY IS THIS NEGATIVE?  Because the current price of the stock is higher than the 1-year average analyst target price. This can be interpreted as the stock being overpriced but it does not mean that a stock will not continue to rise.

Also, this morning:  UnitedHealth Group (UNH), Proctor & Gamble (PG), Morgan Stanley (MS), State Street (STT), and Citizens Financial Group (CFG) beat on EPS and sales while Bank of America (BAC) missed on Revenues but beat on EPS. Still up, Prologis (PLD) this morning, and Alcoa (AA), United Airlines (UAL), and Kinder Morgan (KMI) after the close.

YESTERDAY’S MARKETS

Stocks sold off yesterday in response to rapidly rising bond yields. The S&P500 fell by -1.84%, the Dow Jones Industrial Average sank by -2.51%, the Nasdaq Composite Index dropped by -2.60%, the Russell 2000 Index traded lower by -3.06%, and the S&P500 ESG Index gave up -1.75%. Bonds fell and 10-year Treasury note yields climbed by +9 basis points to 1.87%. Cryptos fell by -3.93% and Bitcoin gained +1.56%.

NXT UP

• Housing Starts (Dec) are expected to have fallen by -1.7% after gaining +11.8% in November.
• Building Permits (Dec) may have declined by -0.8% compared to the prior month’s +3.6% gain.