The Fed, Yields, and Value Back En Vogue
Markets are having a hard time dealing with rising interest rates. Yesterday, the 10-year Treasury rose by 8 basis points to 1.72%. It has been been over 1 year since the interest rate on the bell weather bond has been this high. However, what had the market more concerned is the rapid rise over since year-end. Inflation fears are mounting on top of this and the market doesn't seem to be pleased with the Fed's answer that it's steady-as-she-goes with regard to Fed policy. Meanwhile, investors are shifting to "value" stocks and fleeing some "growth" stocks. Here's what we're seeing this week:
• Where Are Yields Headed? It's anybody's guess where yields will stop, but the momentum would suggest that rates are headed at least a little higher. Various firms disagree with where the 10-year yield will begin ease, but the next hurdle is generally expected to be 2.0%. In our 2021 Outlook, we expected the 10-year to end 2021 at 2.0%. We might get a little reprieve this morning are the 10-year yield is off its highs. What we believe is pushing rates higher is that the economy is normalizing. That means higher inflation and growth from different areas of the market (more on that in a minute). Rising yields are problematic for stocks that are expensive (for example, from a Price-to-Earnings perspective) but good for stocks that are, or have been, trading at a discount. Expect more volatility in yields as the economy continues to re-open. Apple Mobility data shows driving is up 27% from Jan 13, 2020. In just the last 30 days, TSA Checkpoints have seen a 39% increase in passengers flying. Cases and Deaths continue to slowly decline as vaccinations rapidly increase. The economic prospects look good as re-openings occur, signaling that rates may be headed higher.
• No Change In Fed Policy. As some expected, the Fed announced on Wednesday that nothing has changed with their timeline on the Fed Funds Rate and their bond buying program. In fact, Fed Chairman Powell was emphatic at the Wednesday press conference stating, "Until we give a signal, you can assume we are not there yet." The Fed maintained that its goals of full employment and inflation of 2% are the benchmarks for making changes to policy. The market seems to have some schizophrenia as equities cheered the announcement on Wednesday and then sold off on Thursday. The economic picture has not changed much, despite some disappointing releases this week. Most of the economic news this week has been negative except for manufacturing data and business inventories. Weekly Jobless Claims disappointed by increasing to 770,000 versus 720,000 expected. Retail Sales dropped more than forecast, minus 3% versus minus 0.5% expected. Housing data disappointed across the board as Housing Starts, Building Permits, and the NAHB Housing Index all dropped more than expected. Yet, the Fed increased its growth forecast for this year to +6.5%. The financial backdrop was steady on Wednesday as the Chicago Federal Reserve's National Financial Conditions Index was steady at -0.63.
• Value Back En Vogue. As over-priced "growth" stocks benefited from the pandemic shutdown, "value" stocks were nearly abandoned. In 2020, the Russell 1000 Value Index was up only 2.8%, while the tech-laden Russell 1000 Growth Index was up 38.5%. So far this year, the story is a reversal. The "value" index is up 11.7% while the "growth" index is up only 1.2%. The play in 2020 was on technology stocks that would benefit from the economy being shut down and people being dependent on tech for nearly every facet of life - work, play, and even religion. Now, states are rapidly re-opening and yields are on the rise. This has caused investors to flee what were ever-soaring tech names and finding great companies that will benefit form life returning to normal. All of the major banks traded in positive territory despite the broad markets trading in the red. We expect this rotation from "growth" to "value" to continue as interest rates remain elevated from lows and tech remains expensive. Don't expect Technology stocks to fall off a cliff, but by year-end, the value sectors will have out-performed the COVID-darling tech stocks. The last 3 calendar years when value out-performed growth - 2012, 2014, & 2016 - technology stocks still turned in a positive return, even when interest rates were rising (2016).