Some investors may be tempted to buy amid the moderate dips in stock prices, but we lay out the rationale for a more nuanced approach.
By Lisa Shalett – The second half of February brought not just a market selloff, but also indications of a more serious potential shift in market outlook. Just two weeks after hitting a high of 3948 on Feb 16, the S&P 500, the benchmark index of the broader U.S. market, has fallen 3.5%, while the tech-and-growth-stock-heavy Nasdaq index is down about 6.4%. For some, that may seem like the kind of moderate dip that could be a buying opportunity, but we don’t believe that’s the case right now.
A close look at interest-rate dynamics suggests that fundamental market conditions may be changing. In the past two weeks, we’ve seen the benchmark 10-year Treasury yield surge as high as 1.6% from 1.3%—compared with its historic low of 0.5% last August. The recent surge may indicate a reassessment of the speed of the U.S. economic recovery and the likely Federal Reserve policy response.
Investor faith that interest rates would remain stable at very low levels has helped support sky-high price-to-earnings multiples this year. Growth stocks are often valued against the yield on a low-risk Treasury bond—the wider the spread, the larger premium that an investor is expected to pay for the added risk of growth. As rates move higher, stock prices often adjust to reflect that narrowing gap. That may be a big reason why tech stocks, in particular, got hit so hard last week.
Also, survey-based indicators from primary dealers and investors suggest that market participants believe that a tapering of the Fed’s bond-buying program will begin in the first quarter of 2022. For that timeline, the Fed would have to start signaling a shift later this year to avoid major market upset, similar to what we saw with the 2018 “taper tantrum.”
This shift in policy expectations has material implications for portfolio construction, suggesting not only shifts in sector and regional positioning, but fresh approaches to diversification, as rising rates produce potential headwinds for both stocks and bonds simultaneously.
Investors should consider adding economically cyclical sectors that can take advantage of global reflation. We also suggest maintaining positions in defensive sectors that would likely do well if the faster-growth, rising-rate scenario takes longer to materialize than indicators now suggest. more>