A Chainsaw To Stocks As Bond Rates Rise

What market drivers could also impact the credit union investment portfolio?

The positive tone in risk markets continued for much of January. Momentum from the recently passed Tax Cuts and Jobs Act (TCJA) was a tailwind for U.S. equities (S&P 500 +5.7%), and corporate credit spreads tightened another 6 basis points (bps) from what were already post-crisis lows.

However, an increase in long-end Treasury yields as the month progressed began to weigh on equity valuations. In the recently published 2018 Barron’s Roundtable, which surveys top investment experts across several asset classes, most participants are fairly bullish on global growth prospects in 2018. Much of this optimism is attributable to tax reform, and many expect wage and consumer price growth to rise throughout the year.

One common concern is rising bond yields and the impact on stock prices (i.e., higher discount rates). As veteran tech investor Paul Wick describes it, “the discounting mechanism is going to take a chainsaw to stocks with extravagant valuations as rates rise (a bigger impact for tech companies not expecting positive cashflow for many years). ContentMiddleAd

The primary catalyst for higher long-end yields was hawkish rhetoric from European Central Bank (ECB) officials as it relates to the future of its current asset purchase program. This was something we discussed on several occasions last year as a major wildcard for financial markets in 2018. The Fed has been relatively transparent and predictable thus far in its policy normalization process, particularly its balance sheet reduction plan. The ECB has been less forthcoming, but with growth and inflation measures improving in the region, officials are naturally hinting at pulling back on the central bank’s extraordinary accommodation policies as well.

January At-A-Glance

  • Positive momentum in risk markets continued in January (S&P 500 +5.7%).
  • More hawkish rhetoric from ECB leaders weighed on long-end global government bond yields, and quantitative tightening remains a potential headwind for the global economy and markets.
  • Overall U.S. economic data trend remains positive, and the underlying details of the Q4 GDP report were solid.
  • The current expansion cycle is now in its 104th month and will soon only trail the 1990s as the longest post-WW2 expansion (120 months).

The ECB is still actively engaged in quantitative easing, but it has reduced the monthly pace of purchases. Recent statements by officials suggest they are leaning toward letting the current program expire in September. Since mid-December, Germany’s 10-year yield is up 40 bps (more than doubled), and France’s 10-year yield is up more than 30 bps. Over that same timeframe, the 10-year Treasury yield rose 35 bps, which was attributable to both selling pressure from global markets and higher market inflation expectations post-tax reform.

This market overview is provided by ALM First Financial Advisors, LLC, the investment advisor for Trust for Credit Unions. Read more from ALM First about the latest economic data releases and overall market trends at Trustcu.com.

February 5, 2018

Keep Reading

View all posts in:
More on:
Scroll to Top
Verified by MonsterInsights