- Rising bond yields have knocked stock markets, with the Nasdaq turning negative for the year.
- Scott Thiel says higher yields make stocks look less attractive, while the speed of change is worrying traders.
- He also says investors are concerned the Fed will not stamp down on borrowing costs.
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At a time when bitcoin is soaring and day-traders are taking on hedge funds, bonds can seem pretty dull.
But the bond market has sprung back to life over the past few weeks and reminded investors just how important it is – with yields shooting higher and shaking faith in the stock-market rally.
Rising bond yields have triggered sharp falls in the Nasdaq, which is packed full of flashy stocks that soared when returns on bonds were ultra-low. Tesla had tumbled more than 30% over the month to Friday, with Ark’s Innovation ETF down around 26% and Amazon off by roughly 12%.
But why exactly are rising bond yields worrying investors? We asked Scott Thiel, chief fixed income strategist at BlackRock – the world’s biggest asset manager with more than $8 trillion under management – for some answers.
Investors are betting growth will drive inflation
Government bonds – ultra-safe securities that governments sell to borrow money – are the backbone of global markets, with the US Treasury market worth around $21 trillion.
In recent weeks, yields on bonds have risen sharply as investors have dumped government securities at a rate not seen since Donald Trump was elected in 2016. (Yields are the rate of return bondholders can expect, and they move inversely to prices.)
Investors now think economic growth will roar ahead in 2021, causing a rise in inflation. As a result, bond-buyers are demanding a higher return to make up for price erosion and because there are other good investment opportunities. Some investors also think central banks could now start cutting back their support sooner than expected.
The yield on the key 10-year US Treasury note stood at 1.574% on Friday, up from 0.92% at the start of the year.
The dividend yield on the S&P 500 – how much on average the companies listed on the index pay out in dividends each year relative to their stock price – is around 1.57%, according to Bloomberg data. For the first time since late 2019, 10-year notes are yielding more.
Thiel, who has managed some of BlackRock’s biggest bond funds, sees three key drivers: The arrival of coronavirus vaccines, which will let economies reopen; the Democrats taking control of the US Senate and planning $1.9 trillion of stimulus; and a huge amount of pent-up demand thanks to people saving money during lockdown.
“If you put those 3 things together… it has put the economy on a very aggressive reopening stance,” he says.
Rising bond yields hit company valuations
But why are stock markets nervous when growth is expected to be so strong? Thiel’s explanation can again be broken down into 3 parts.
Firstly, he says “the most important thing to think about” is that bond yields and inflation are key factors in judging what companies are worth.
If borrowing rates and inflation look likely to stay low for a long time, then the returns and earnings of stocks become more attractive. Lower interest rates also hold down companies’ borrowing costs.
Low rates therefore caused a surge in the shares of fast-growing, high-earning companies like Amazon, Apple and Google, helping the Nasdaq soar more than 80% since its March 2020 lows.
But Thiel says: “If you shift that dramatically, in a very short period of time, and imply that that may be just the beginning of rate increases, you can have a situation where equity markets don’t like that very much at all.”
The Fed’s stance has worried investors
This leads to another, related explanation of the market jitters. Investors worry the Fed and other central banks will allow rates to rise, without intervening.
Markets have become used to the Federal Reserve holding down bond yields and pumping money into the economy. But Thiel says the Fed has “basically declined to… hit any kind of alarm button at all” over the rise in borrowing costs.
He says the Fed has in fact signaled “the opposite, which was to say that this was consistent with how they thought the market should play out.”
Fed Chairman Jerome Powell disappointed markets on Thursday when he signaled the central bank is happy keeping policy as it is for the time being.
Kit Juckes of Société Générale said in a note it was “not the message markets wanted to hear”, which triggered another slide in stocks and spike in yields.
Rapid changes catch stocks off guard
Finally, the sheer speed with which bond yields have risen has taken markets by surprise, Thiel says.
Some of the daily moves seen in bond markets were “very, very, very big,” he says. “So I think it was very much a feature of a very quick move that we saw in rates… I think it caught the market a little off guard.”
Goldman Sachs analysts said in a note investors are suffering “indigestion” as they rapidly re-value stocks in light of changing bond prices.
Shane Oliver, head of investment strategy at AMP Capital, said in a note that the rise in yields had triggered a fast rotation “away from last year’s winners like tech stocks, to cyclical shares like financials and resources that will benefit from stronger economic conditions.”
Despite the recent stock-market turbulence, Thiel remains optimistic about the outlook for stocks because the rapid recoveries expected, especially in the US and China.
“We don’t believe that markets are dramatically overvalued at this point,” he says, adding that there’s “a lot of economic growth coming.”