I just need to get this off my chest. The market has been on a roller coaster this week, with a mini tech wreck Monday and Tuesday morning and a bounce Tuesday afternoon after Federal Reserve Chairman Jerome Powell's usual dovish jawboning during congressional testimony, followed by a wishy-washy start to trading on Wednesday
But make no mistake, the move higher in Treasury yields -- -the 10-year U.S. Treasury at this writing is quoted at 1.41% -- is real and really dangerous for the bulls. I look at Bloomberg's rates and bonds page and I believe the far-right columns are the most important. The actual rate isn't important; it is the change in rate. And the yields on the 10-year and 30-year U.S. Treasuries are now higher than they were one month and one year ago.
That's what matters. Higher interest rates are contractionary to any economy. Always did and always will. Also, mathematically, a higher prevailing interest rate will always yield a lower fair value for a stock (or the stock market) using formulas such as the Capital Asset Pricing Model. Always were and always will be.
While a steeper yield curve helps the financial sector because of the lend long/borrow short nature of banking, this market seems to believe that tech is hurt the most by rising interest rates. Consider this depiction by CNBC:
The reversal in futures came as the 10-year Treasury yield hit a high of 1.42%, its highest level since February 2020. Higher interest rates... could prompt investors to rotate out of high-flying stocks and into bonds, while they could hamstring growth companies like tech, which benefited from the low-rate environment.
That is complete baloney. I can't think of a group of U.S. companies less impacted by higher interest rates than the FAANG complex. Some add Tesla (TSLA) to that group to create a FATANG acronym. I spent more than a decade of my life following the auto industry, so I know the strong correlation between auto sales and interest rates. Higher rates are not good for Elon Musk, but what about Jeff B, Zuck, Cookie, Sundar and Reed?
This is where the distinction between stocks and companies is extraordinarily important. Do you think interest rates matter to Facebook (FB) ? Of course they don't. Mark Zuckerberg's company is not heavily leveraged, and FB's ad revenue-driven model would be just as viable amid 10% interest rates as it was when the 10-year yield hit an all-time low of 0.318% last March.
But those are company fundamentals. Equities as an asset class are indeed sensitive to interest rates, as they should be, though the media often doesn't depict the reason why properly.
When yields are rising, it is because bond prices are falling. No bond fund manager on Earth attempts to buy a bond for a capital loss.
So, for Grandma, a 1% yield on a CD may look better than 0.5% -- and conversely, a 3% rate on a mortgage looks much worse than 2.5% -- but that is not what drives the guys at Pimco If investors were attracted to new, higher interest rates, they would buy enough bonds that those rates would go back down. That is not what is happening.
The problem here, as with so many other issues, from GameStop (GME) to infinity, is that the U.S. stock market's valuation is built on a foundation of free money. Whether that comes from Jerome Powell or Vlad Tenev at Robinhood, it is the same. Low borrowing costs have fueled this stock boom, and higher borrowing costs -- even if they have negligible impact on the actual fundamentals of the largest U.S. companies -- will sure as hell kill the boom.
So, watch out. And watch bond quotes. A year ago I would have never thought that a move from 1.0% to 1.4% on the 10-year Treasury yield would be enough to spook the stock markets, but five years ago I never would have thought that a 1.0% yield on the 10-year was possible. When one bubble pops it tends to pop others. Remember 2001? 2008? Could it happen in 2021? Pay attention!