Saturday, 20 October, 2018

Rising bond yields could win next round in battle with stock market

Global bond markets sell-off triggered by central bank policy worries Global bond markets sell-off triggered by central bank policy worries
Elsie Buchanan | 12 February, 2018, 01:25

After a three-decade period when falling interest rates and bond yields provided a boost to stock prices, the potential for a sustained rise in yields has equities deep in the red in recent days. A PE ratio of 24.53 for BSE Sensex on Friday suggested that investor were willingness to pay Rs 24.53 for every Re 1 of Sensex earning.

Benchmark 10-year notes last fell 2/32 in price to yield 2.8403 percent, from 2.832 percent late on Wednesday.

During its recent rally, the domestic stock market was overlooking the rising bond yields on some "misguided view" about earnings and macro-economic factors being less relevant for the equity market against ample global liquidity, Kotak Institutional Equities said in a recent note. U.S. bond yields rose sharply on Monday after official data released on Friday showed USA wages were increasing at the fastest pace since 2009. Growing confidence in the current synchronised global economic expansion, the inflationary impact of U.S. stimulus and expectations of higher wage pressures have contributed to investors' reassessing central bank policies and longer-term inflation expectations. As of Monday morning, the BSE Sensex is off almost 1,700 points from its all-time high of 36,443, while midcap stocks were bleeding even more.

Investors are weighing whether the sharp swings this week are the start of a deeper correction or just a temporary bump in the prolonged bull market.

For some analysts, this move is overdue. The leak of a Federal Bureau of Investigation memo on Trump's Russian Federation "dossier" complied by a British ex-MI6 intelligence officer has also unnerved stock market bulls about rising political risk in Washington. But such calm is unusual, and stocks overheated.

Consider this: The S&P 500 has risen or fallen 1% five times in the past two weeks. That only happened eight times all of a year ago.

"You are beginning to see the edge taken off the United States economy as capacity has disappeared", Warner said. But once stocks react too much to rising interest rates, traders expect a flight to safety back to bonds, which would drive yields lower. That's a big spike from just 2.65% during the panic selling Monday afternoon.

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Equities for years have looked relatively attractive compared to the low yields offered by bonds, but the rise in Treasury yields has diminished the lure of stocks, especially with stock valuations at historically expensive levels.

Washington is putting more pressure on rates. At the same time, the USA deficit is growing and would be bumped up even more by the Senate budget deal, if it passes Congress. After all, the government deficit is soaring because of massive tax cuts, and the Federal Reserve is trimming its nearly $4.4tn portfolio, which contains billions of dollars' worth of bonds acquired in an effort to prop up the economy in the wake of the fiscal crisis.

Wall Street anticipates that more government spending will force the Treasury Department to borrow more money by selling additional bonds. To drum up demand for that higher supply, rates may have to go up.

Bank of America analysts warned that the Senate agreement will contribute to "higher rates" and raise "risks for tighter overall financial conditions".

On Thursday, the Dow and S&P 500 indexes slumped more than 10 percent from their January 26 record highs, confirming they were in correction territory and leaving investors wondering when the market's recent slump would find a floor. The fragile rebound lifted the market a bit, and the Dow and S&P 500 are now about 8% off their from all-time highs.

Emerging market stocks lost 0.88 percent.

The Dow Jones Industrial Average fell 1,032.89 points, or 4.15 percent, to 23,860.46, the S&P 500 lost 100.66 points, or 3.75 percent, to 2,581 and the Nasdaq Composite dropped 274.83 points, or 3.9 percent, to 6,777.16. The job market remains healthy, as evidenced by a report Thursday that applications for unemployment benefits are at a 45-year low.

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