U.S. Treasury bonds have been locked in a six-week selloff,
with yields moving steadily higher as prices fall. The 10-year U.S. Treasury bond
yield started 2021 under 1%, but it has marched upwards ever since. The yield
crossed 1.5% by the first week in March.1 Looking ahead, all signs
point to even more upward pressure on long-dated U.S. Treasury bond yields this
year. As you can see from the chart below, the 5-, 10-, and 30-year U.S.
Treasury bond yields have all been drifting higher since last summer.
The 5-, 10-, and
30-year U.S. Treasury Bond Yields (March 2020 – March 2021)
With anticipation surrounding the next stimulus, expected
economic growth and inflation expectations, there are many unknows surrounding
the market. As we witness market changes, I understand how planning your future
economic situation can cause lots of uncertainty. Instead of making sudden and
emotional investment decisions, I recommend focusing more on the hard data and
economic indicators that could impact your investments in the long-term!
To help you do this, I am offering all readers our just-released
Stock Market Outlook report. This report contains some of our key forecasts to
consider such as:
Financial
stability lessons from the COVID-19
Setting
U.S. returns expectations for 2021
Outlooks
for the underlying U.S. and Global Economies
The conditions that generally lead to rising rates all apply
to the current environment, in my view:
Anticipation of large fiscal stimulus passing in
the near-term;
Accelerating economic growth expected in coming
quarters (and perhaps years);
Rising inflation expectations.
I’ll stop short of making any predictions about where the
10- or 30-year U.S. Treasury bond might finish the year. But from what I see
today, the outlook is clear: longer-term interest rates are on the rise, and there
are four key takeaways I think investors should consider. Here they are.4
Takeaway#1: High-Growth, High Valuation Stocks are
Riskier
Many readers have probably seen the stories in the financial
headlines: rising interest rates are putting pressure on technology stocks.
Indeed, the tech-heavy Nasdaq entered correction territory last week, while the
S&P 500 has fallen by only a modest amount over the same period. The
question is, why do higher rates hurt tech stocks?
Here’s the simplest answer I can offer: when interest rates
are very low, liquidity in the capital markets tends to flow into risk assets.
Investors in search of yield know they can’t find any in U.S. Treasuries and
most types of bonds, so they buy stocks. Since interest rates have been low for
a long time, investors have been comfortable investing in high-growth/high-risk
tech names, bidding up prices in the process.
However, as interest rates start to tick higher, stocks
cease to be “the only game in town.” This means all the excess liquidity now
has more places it can go, which diminishes the relative attractiveness of
stocks, but especially the most expensive
stocks. This does not necessarily imply that a tech bubble is about to burst –
but it does mean the market may take some to adjust to higher rates, which
could mean elevated volatility for high valuation names. Check your portfolio
for exposure.
Takeaway #2: A Better
Profit Outlook for Financials
Steep, upward sloping yield curves tend to be good news for
banks, and the yield curve is currently getting steeper.
The chart below shows the 10-year U.S. Treasury bond yield
minus the 3-month Treasury bond yield, which is a good barometer for the yield
curve. When the line moves higher, the curve gets steeper:
Steep yield curves are good for banks because of net
interest margins on loans. When a bank makes a loan, it generally accesses
capital at rates on the short end of the curve (basically free money currently)
and loans the money out at longer-term rates. The steeper the yield curve, the
bigger the difference between short and long rates, which also means bigger
bank profits. The Financials sector has a favorable outlook as a result.
Takeaway #3: Capital
May Rotate from Growth to Value
Over the last 10 years (through 2020), the Russell 1000
Growth Index has delivered an annualized return of around +17%, while the
Russell 1000 Value Index has annualized about +10% over the same period. Since
2007, the outperformance of growth relative to value is approaching levels not
seen since the 1930s and the dot com bubble. In fact, the spread between the
price-to-earnings (P/E) ratio on growth and the P/E ratio on value stocks is
the highest it has been since 2000, when the bubble burst on many growth names.
As I mentioned before, I’m not suggesting we’ll see a tech bubble burst in
2021, but I do believe it is just matter of time before investors rotate
capital away from growth and towards value. Rising interest rates may nudge
this rotation along.6
I’ve already made the case for rising interest rates hurting
tech stocks, which also means hurting the growth category. But rising inflation
expectations play a role here too – upward pressure on inflation may eventually
put some pressure on the Federal Reserve to tighten monetary policy, which
recent history suggests could give way to market volatility and “taper
tantrums.” As mentioned, selling pressure in response to higher inflation and
tighter monetary policy will most likely impact areas of the market with
relatively high P/E ratios. This could mean a reality check for growth stocks and
could trigger an investor rotation into value.
Takeaway #4:
Rethinking Retirement Fixed Income Allocations
I do not like making long-term forecasts for interest rates
or the stock market. Anything can happen from year to year, so it’s important
to assess as you go. It’s clear to me, however, that the outlook for risk-free
fixed income, i.e. Treasuries, is looking bleak for current and future
retirees. The bull market in Treasuries (from 1980 to recent years) is running
out of steam, and investors will need to content with low yields that look
poised to move higher. Remember, rising yields means falling prices.
I think current and future retirees need to rethink fixed
income allocations in retirement portfolios, exploring different types of bonds
like corporates and municipals, and also exploring income-generation via other
avenues, like dividend stocks and preferred.
Bottom Line for Investors
As you can
see from this lengthy column, rising interest rates have many implications for
investors. In my view, now is a good time to take a closer look at your
portfolio allocation, and to potentially make a few adjustments if your goals
and risk tolerance allow. If you want some help conducting your portfolio
review, reach out to us today. We’d be happy to help.
In addition to taking a close look at your portfolio, in times like these, it is important to stay focused on key data points and economic indicators that could positively impact your investments in the future. To guide you, I am offering all readers our Just-Released April 2021 Stock Market Outlook Report.
This report looks at several factors that are producing optimism right now and contains some of our key forecasts to consider such as:
Financial
stability lessons from the COVID-19
Setting
U.S. returns expectations for 2021
Outlooks
for the underlying U.S. and Global Economies
S&P
500 earnings growth
What
produces 2021 optimism?
Is
it time to buy U.S. stocks?
Update
on U.S. fiscal stimulus
And
much more…
If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today!
1 U.S. Department of Treasury. March 8, 2021. https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/TextView.aspx?data=yieldYear&year=2021
2 Fred Economic Data. March 5, 2021. https://fred.stlouisfed.org/series/DGS10#0
3 Zacks Investment Management reserves the right to amend the terms or rescind the free Stock Market Outlook offer at any time and for any reason at its discretion.
4 Wall Street Journal. March 8, 2021. https://www.wsj.com/articles/global-stock-markets-dow-update-03-08-2021-11615192681?mod=hp_lead_pos1
5 Fred Economic Data. March 8, 2021. https://fred.stlouisfed.org/series/T10Y3M#0
6 Forbes. November 12, 2020. https://www.forbes.com/advisor/investing/value-vs-growth-stocks-performance/
7 Fred Economic Data. March 5, 2021. https://fred.stlouisfed.org/series/DGS10#0
8 Zacks Investment Management reserves the right to amend the terms or rescind the free Stock Market Outlook offer at any time and for any reason at its discretion.
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The S&P 500 Index is a well-known, unmanaged index of the prices of 500 large-company common stocks, mainly blue-chip stocks, selected by Standard & Poor’s. The S&P 500 Index assumes reinvestment of dividends but does not reflect advisory fees. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor. An investor cannot invest directly in an index.
The Russell 1000 Growth Index is a well-known, unmanaged index of the prices of 1000 large-company growth common stocks selected by Russell. The Russell 1000 Growth Index assumes reinvestment of dividends but does not reflect advisory fees. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.
Nasdaq Composite Index is the market capitalization-weighted index of over 3,300 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks, as well as limited partnership interests. The index includes all Nasdaq-listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debenture securities. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.
The Dow Jones Industrial Average measures the daily stock market movements of 30 U.S. publicly-traded companies listed on the NASDAQ or the New York Stock Exchange (NYSE). The 30 publicly-owned companies are considered leaders in the United States economy. An investor cannot directly invest in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.
Returns for each strategy and the corresponding Morningstar Universe reflect the annualized returns for the periods indicated. The Morningstar Universes used for comparative analysis are constructed by Morningstar (median performance) and data is provided to Zacks by Zephyr Style Advisor. The percentile ranking for each Zacks Strategy is based on the gross comparison for Zacks Strategies vs. the indicated universe rounded up to the nearest whole percentile. Other managers included in universe by Morningstar may exhibit style drift when compared to Zacks Investment Management portfolio. Neither Zacks Investment Management nor Zacks Investment Research has any affiliation with Morningstar. Neither Zacks Investment Management nor Zacks Investment Research had any influence of the process Morningstar used to determine this ranking.
The Russell 1000 Value Index is a well-known, unmanaged index of the prices of 1000 large-company value common stocks selected by Russell. The Russell 1000 Value Index assumes reinvestment of dividends but does not reflect advisory fees. An investor cannot directly invest in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.