Analysis-Bond yield spike is risk to unprepared equities market, investors warn
By Suzanne McGee
PROVIDENCE, Rhode Island, May 17 (Reuters) – Investors are warning that strong U.S. stock markets have not yet priced in the risk of skyrocketing inflation and are vulnerable to a sharp rise in bond yields.
Stock markets were buoyed by strong first-quarter earnings and expectations of support from artificial intelligence; This overshadowed the risk of higher energy prices and the failure to end the war with Iran.
But last week’s rise in bond market yields — which pushed the 30-year Treasury note above 5% and the benchmark 10-year bond above 4.5% — could change the picture for investors. This situation caused caution in the stock market on Friday.
Paul Karger, co-founder and managing partner of TwinFocus, which manages money for ultra-high-net-worth families, said his clients bombard him with questions every time he meets with them about how to understand the apparent market paradox.
“Breakfast, lunch and dinner: The question is always how do we make sense of the fact that this is such a fragmented view,” Karger said. While Karger told a positive story, he said that oil prices and inflation emerged as a negative development for companies.
Karger has a self-described “barbell” approach to the assets it manages: It accumulates overweight positions in cash, gold and other commodities, while maintaining positions in the market’s leading mega-cap growth stocks.
After the first blackout following the start of the US-Israeli war with Iran in late February, US stock market indexes have rebounded sharply. The benchmark S&P 500 index is last up more than 17% since its yearly low in late March and has gained more than 8% year-to-date despite a nearly 1% pullback on Friday.
Rising benchmark yields tend to put pressure on equity valuations as companies and consumers face higher borrowing costs. This could also weigh on economic growth and corporate profits, possibly making bond yields more competitive with stocks.
This may be especially true now that the stock market is at high levels. As of Thursday, the S&P 500 index was trading at 21.3 times earnings estimates for the next 12 months, according to LSEG Datastream. That’s well above the index’s long-term average forward price-to-earnings ratio of 16, but below the 23.5 level it reached in October as a strengthening U.S. earnings outlook helped keep valuations somewhat in check.
“I think there’s a real fear that inflation is kind of embedded in the direction of the economy,” said Peter Tuz, president of Chase Investment Advisor in Charlottesville, Virginia. “You don’t see any signs of a decline right now and that’s a real fear and if it continues it will drive the market down.”
