Stocks had a mixed close on Friday as growth stocks came under pressure from rapidly rising 10-year yields. Bond yields are rising and the back end of the curve is now inverted leaving investors concerned that something may be about to hit the fan.
The calm before. Yeah, there is that hackneyed term about the storm coming, and you are thinking “wait, it could get more crazy than this?” Well, ya, it can. Here we are, the Fed just raised rates for the first time since 2018. Rates have effectively been tacked at 0% since the onset of the pandemic in early 2020. The Fed, though outwardly calm, is in a really tough bind. Inflation is at its highest level in 40 years and the war in Ukraine is likely to cause prices to spike yet higher. The Fed is raising rates hoping to cause consumers and companies to spend less money and reduce the pressure on prices. If the Fed raises too fast, slams on the brakes, it could cause a recession…bad. If the Fed goes too slowly, it risks an economic stall which would be slow growth and high inflation. For the record, economists call that stagflation. You have surely heard the term and you likely associate it with bad times for the economy. If so, you would be correct. As of, say…just two weeks ago, the Fed raised rates by +25 basis points and predicted 6 more +25 basis point augmentations. However, by last week, Fed members began to change their tunes and are now starting to call for a +50 basis point hike at their May confab.
In recent times, the Fed has stuck to 25 basis point increments in both directions. In fact, even going back to the 1970s…ahh the 70s…the Fed has raised rates by +50 basis points 15 times out 184 up and down moves. Now, to be clear 44 of those moves were 50 basis points or less while 44 of them were 50 points or greater. Yes, the Fed, indeed raised rates by even more than +50 basis points in the past, but thankfully, there is no chatter of that at this point. In any case, the stock market has, so far, taken it in stride. Bond markets have certainly factored a bigger hike in. However, the bond market seems to be at odds with what exactly it all means for the future. At the front end of the curve, 2-year Treasury Note yields ended 2021 at around 0.73% and by March 16th when the FOMC moved the Fed Funds rate up, those yields were around 1.90%. Those short-maturity yields are a good representation of what the markets expect rates to be in the near future. By last Friday, those yields got to 2.25% and Fed Funds futures now predict a 67% probability of a +50 basis point rate hike at the Fed’s May 4th meeting. The farther out we move on the yield curve, the more yields reflect investor’s opinions on longer term economic conditions, particularly on inflation. A good benchmark for that is the 10-year Treasury Note, which has also been sporting higher yields as of recent. It started off 2021 around 1.5% and is now at around 2.46%. Despite common misconceptions, those yields have not risen because of the Fed but, rather, because investors are expecting inflation to persist, and they would like to get compensated for that inflation. Those yields have not only risen year to date, but they have literally jumped by some +64 basis points, or +0.64% in this month alone. That shows that investors are increasingly expecting inflation to continue in the longer run. Now, here is where it gets a bit trickier. If investors get spooked and believe that inflation may be on the horizon, longer term Treasury Note yields will begin to fall, even if the Fed is raising rates at the time. When that happens the yield curve inverts, which is a well-known indicator that a recession may be in the offing within 18 or so months. While that hasn’t quite happened yet, the curve between 5-year and 10-year tenors has inverted and has put economists on yellow alert. The 2-year/10-year curve is still positive at around +20 basis points, but it has been flattening and is still quite flat considering that the Fed is only at the beginning of its economic growth-curbing outing. For now, the fact that 10-year yields are rising is a sign that bond traders are not yet worried about a recession, though the higher yields are certainly not helping growth stocks. However, if the Fed could thread the needle and raise rates just enough to cause inflation to pull back, but not by too much that the economy doesn’t fall into a recession, it would certainly be good news for on-edge stock investors. Meanwhile, we have a full week of economic numbers which not only include important employment numbers but also the Fed’s favorite inflation gauges which are likely to give the Fed hawks the ammunition they need for a +50 basis point hike just 37 days from now. In the interim we can certainly expect 2-year note traders to continue to battle it out with 10-year note traders leaving growth stock traders in choppy waters. Hold on tight, stay hydrated, keep your eyes on the horizon.
WHAT’S SHAKING
Qorvo Inc (QRVO) shares are down by -3.35% in the pre-market in response to Goldman Sachs revising its 12-month target down to $138. Potential average analyst price target upside: +35.9%.
Tesla Inc (TSLA) is trading higher by +6.37% in the pre-market after it was reported that the EV maker is seeking approval for another stock split. Potential average analyst price target upside: -7.1%. WHY IS THIS NEGATIVE? Because the current share price is above the average 12-month analyst target price. While it may be interpreted that the stock is expensive, it does not mean that the stock will not continue to climb.
FRIDAYS MARKETS
Stocks had a mixed close on Friday as tech shares were under pressure from rising Treasury yields. The S&P500 rose by +0.51%, the Dow Jones Industrial Average gained +0.44%, the Nasdaq Composite Index lost -0.16%, the Russell 2000 Index advanced by +0.12%, and the S&P500 ESG Index added +0.47%. Bonds slipped and 10-year Treasury Note yields gained +10 basis points to 2.47%. Cryptos gave up -0.81% and Bitcoin added +1.55%.
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