I’ve said it how many times? The rapidity and reason for a given move higher in rates very often matter more for equities than the absolute level of yields.
That’s a rhetorical question, but also not. I’d genuinely like to know how many times I’ve said that over the last eight or so years, because it’s a lot, and simple though it is, the point’s often lost in the quest to determine “thresholds” and “key levels” beyond which stocks won’t tolerate additional increases in bond yields.
As far as the “rapidity” point, a good rule of thumb (it’s actually Goldman’s rule of thumb) is that a two standard deviation move in yields over any rolling one-month window should generally be expected to give equities heartburn, particularly if stocks are trading rich (i.e., if multiples are stretched).
On the “reason” point, there’s a lot of nuance to grasp, but the bottom line is that as long as stocks can make a case that rising yields are a function of an improving growth outlook, they (equities) can stay supported, and certain sectors might even outperform. Stocks have a way of hearing what they want to hear and seeing what they want to see, so at least initially, equities are capable of writing off either rising breakevens or rising reals as favorable in the context of repriced growth expectations.
What stocks won’t happily countenance are rapidly rising reals (i.e., an acute FCI tightening impulse) or a scenario where yields grind higher even as growth outcomes disappoint relative to consensus. From late-November right up until the release of the December CPI report earlier this month, that latter scenario is what investors were compelled to grapple with, and it goes a long way towards explaining the shallow equity swoon over that period.
I feel like this is a point which really can’t be belabored too much, and with that in mind, I wanted to present the annotated charts below from Morgan Stanley’s Mike Wilson.
For the uninitiated (hell, really just for anyone), that’s a helpful reference guide. Pay special attention to the red annotations.
“The reasons behind the move in yields are even more important to explaining equity market performance than rate levels,” Wilson said Monday, adding the following color and context, which I’ll present without further comment.
From September through November, the rise in the 10-year yield coincided with persistent upside in the Bloomberg US Economic Surprise Index as macro data beat lowered expectations following the weak July ISM and payroll reports. Index multiples rose and cyclicals (i.e., economically-sensitive areas of the market) outperformed, offering confirmation that there was momentum behind the recovery in macro data. Rate cuts were getting priced out of the bond market, and the term premium was up slightly, but the equity market was focused on prospects for a cyclical recovery — this was a “good is good” environment. What changed in December? Upside in yields was driven by a higher term premium, and economic surprises fell. Multiples, in turn, compressed amid the rise in the term premium and less dovish Fed guidance. Rate sensitivity had returned as the 10-year yield pushed above the 4.50% level we had been focused on (also the point at which rates weighed on stocks in April of last year). Since mid-January, stocks have stayed inversely correlated to yields, but that rate sensitivity has shifted in the other direction post the lighter than expected December CPI report. As Exhibit 13 shows, yields have come in more recently as the term premium has fallen. Meanwhile, the economic surprise index has risen. The equity market has liked this combination as rates have stopped their ascent and growth data has been somewhat more resilient relative to expectations.
