The blistering pace of gains in the stock market took a very minor hiatus this week and it’s pretty clear why. The chart of the 10-year bond future is moving in near lockstep with the Nasdaq 100 NDAQ as investors process what rising rates mean for high-growth, high-valuation companies.
Thursday’s jobless claims were indeed worse than expected, but it’s pretty clear that’s not the issue on investors’ minds. Economic data overall are crushing expectations, and everyone’s well aware of the cracks in the employment situation by now, so there’s nothing really game-changing there. It looks more like the opposite, situation, in fact: faster-than-expected economic recovery is making investors revisit what kind of assets they want to own.
Rising Treasury yields are picking up momentum, and tech stocks are dragging on the market, down 1.5% on the week second only to utilities, the purest interest-rate sensitive group in the market. It’s not much to write home about yet, but it will be if the bond selloff accelerates, or even if it just continues at this pace. Drawing a straight line through the current slope of the 10-year yield chart since August gets you to 2.3% by year-end. Compare that to the average economist estimate of 1.45%, according to Bloomberg. The yield may not be high, but it is already ripping through expectations.
So far stocks seem largely OK with it, but that likely won’t last if reopening picks up speed. Thankfully, investors have a pretty clear blueprint for what to do if yields jump: look back to September 2019. That’s when the trade war came to an anticlimactic close, Powell said he was done cutting rates, and bond yields posted the sharpest weekly percent gain in 30 years. That spurred a “quant quake” in which momentum stocks were thrashed, value stocks rallied, and all the major trends flipped on their head for a minute. It’s very easy to see how such an event could happen today, with even more ferocity.
I ran a scan of the market during that period (Sep 3-13, 2019) to get a better sense of what would be exposed today if such an event occurs.
Momentum stocks that were the best performers over the preceding six months were of course highly correlated with underperformance, but sorting by companies whose price to sales climbed the most did a better job of isolating the stocks that got hit the hardest: the top decile of valuation gainers in the S&P 500 lost a median 3.8% during the period, compared with a 1.5% decline in the stocks whose price had risen the most. There were 767 companies in the Russell 3000 Index whose price/sales ratio was up from the year prior, with an average gain of 0.5 points. Today, 1,815 have seen that valuation climb, for an average 1.7 points.
This market today is much, much more exposed, and the companies that look at risk span a wide array of sectors and themes. There are tons of pharma stocks (TGTX, MRSN, ARNA, INO), software companies (TWLO, DDOG, ROKU, OKTA OKTA), and of course, electric vehicle plays (WKHS, FCEL). But there are also recovery stocks like LVS, WYNN, and BKNG, and new-era staples like TWTR, ISRG and NVDA. In the S&P 500, Tesla TSLA comes in as the second-riskiest stock using this measure. OK fine, the headline’s a little misleading). Its price to sales rose almost 18 points over the past 12 months, second only to Enphase Energy ENPH. Etsy and Align Technology are right behind. Find my newsletter over on LinkedIn for the full list of at-risk stocks.
Simply put, if the past is any precedent, a spike in rates like we got in 2019 would likely be a very destructive force for a broader swath of the market this time around.