Bloomberg
Beaten bulls suggest that prices are rising for “right reasons”
(Bloomberg) – With Tesla Inc. leading yet another sell-off of momentum darlings amid rising bond yields, some investors fear it means the 11-month bull market is in trouble. The surge in returns over the past week has certainly messed up the nerves of assets. On the fringes of the stock market, where signs of a surplus have become evident, investors are saving themselves. Tesla was down more than 10% as of 10 a.m. in New York, after falling 8.6% on Monday. Bitcoin even fell 18%. In a broader sense, however, rates remain relatively low. Compared to return readings, stocks still offer a premium that is almost four times the historical average. If anything, profits could skyrocket if Wall Street economists revamp their forecasts for economic growth to levels not seen in decades. This would justify stock valuations that appear stretched by some traditional yardstick. The bulls’ argument for stocks at a time of rising interest rates is that bond sell-offs are caused by signals coming from commodity markets and economic data such as retail sales. The Biden administration stands ready to pass a massive spending bill, and Federal Reserve Chairman Jerome Powell, who testifies before Congress Tuesday, is determined to keep short-term interest rates near zero. “If we look at the landscape today, interest rates are rising for the right reasons,” said Peter Mallouk, managing director of Creative Planning. Though some think the market must fall as it trades at the high end of valuations, he said, “The reality is it can stay high while earnings grow in.” The stocks that have been most under pressure this week stand, own the sky. high valuations that are harder to justify with rising government bond yields. And a valuation method sometimes called the Fed model, which compares corporate earnings to bond yields, has started moving against bulls. Right now, the S&P 500’s earnings return – how much profit you make in relation to stock prices – is about 1.79 percentage points above the 10-year Treasury yield, its smallest benefit since September 2018. But any warning from this metric , is dim. The current premium is still well above the 48 basis points average in Bloomberg 1962 data, which means that all other things being equal compared to history, stocks can still be rated attractive if the 10-year returns stay below 2.67%. Returns were recently at 1.36%. In a note released earlier this month, strategists at Goldman Sachs Group Inc., including Ryan Hammond and David Kostin, said stocks are usually able to digest gradual rate hikes, especially when driven by growth rather than Fed policy . What tends to cause turbulence in stocks are sharp rises. Stocks usually fall on average in any given month when interest rates rise two or more standard deviations, which is 36 basis points these days. Yields are up 30 basis points this month, hitting a 12 month high. Katie Nixon, chief investment officer at Northern Trust Wealth Management, agrees: “While interest rates may have risen under the tailwinds of upward revisions in growth and inflation, both variables are usually positive for stocks too – up to a point” said Nixon. “Risk-weighted asset markets will only react negatively when interest rates rise in a disorderly manner.” Still, anyone nervous that stocks have outperformed fundamentals can be comforted by the recent rise in returns. In August, as the S&P 500 fully rebounded from losses during the 2020 bear market, 10-year yields sent a threatening signal with a decline to record lows. In a sense, the catch-up in yields suggests that the bond market is finally confirming the bullish economic message that stocks have been flashing since last March. Another way of looking at it: stocks are looking extremely streaked based on past reported gains for 12 months including the pandemic recession. In this metric, the price-earnings multiple of the S&P 500 was 32, surpassing the high of the dot-com era. The drop in value is a little more encouraging compared to this year’s profit. As analysts expect earnings to jump 23% to USD 171 per share, the P / E ratio drops to 23. If the company continues to significantly outperform estimates, the picture would improve. Earnings in the fourth quarter were 16% higher than expected, a pace of positive surprises that, if continued to increase, would boost earnings to $ 198 per share from 2021. That would be a multiple of 20. “What appears to be very high US stock valuations is justifiable if (and only if) earnings decline sharply in the second half of the year,” wrote Nicholas Colas, co-founder of DataTrek Research in a recent note. “There are certainly microbubbles (some SPACs, IPOs), but there is also a good case that stocks as a whole can and will find their way into high valuations.” That’s not to say that returns on stocks don’t matter right now. Money quickly flowed out of high-valued stocks like Tesla, with the Nasdaq 100 falling for a sixth day, its longest losing streak since August 2019. At the same time, companies that benefited from an economic rebound performed better. “Investors did better not position themselves in areas like finance and energy that really benefit from rising returns and rising commodity prices. I think there’s a bit of a mess, ”said Lori Calvasina, head of US equity strategy at RBC Capital Markets, in an interview with Bloomberg Television. “It is more of a repositioning within US stocks than an exit from US stocks.” (Updates to Tuesday prices in the second and penultimate paragraph) For more articles like this, visit bloomberg.com. Sign up now to stay ahead with the most trusted business news source. © 2021 Bloomberg LP