The story this week continued to be interest rates and the speculation about just how high they are going to go. The yield on the 10-year hit a high of 1.63% Friday before backing off. Over the years we’ve noted that the markets tend to fixate on a single issue at a time. Elections, pandemics, or banking problems can all capture the market’s attention at one point or another. But almost always a single issue is the topic of the day to the exclusion of everything else. We are in one of those periods where interest rates are the topic of debate.
Friday’s employment report turned up the heat on the discussion. Nonfarm employment increased by 379,000 in February, almost double expectations. The number would likely have been even stronger without the depressing effect of unseasonably bad weather in parts of the country (yes Texas, everyone is looking at you!). Revisions to prior months now show a bigger jobs dip in December (-306,000) and a firmer recovery in January (166,000). The industrial composition of employment growth displays the clear imprint of the virus on the economy: restaurant and bar jobs increased by 286,000 last month, recouping some of the 390,000 positions lost in the last two months of 2020. Again, this should continue to improve in the next couple months as certain states reopen (we are still looking at you Texas!). The unemployment rate ticked down to 6.2%, which was a tenth better than expected, as you can see below.
This played into the theme that has been going around of late that the economy is poised to boom later this year. And there is something to that. But lost in the discussion is just how big a hole we have to dig out of. As you can see below, even with the increase in employment in the last few months, job losses to-date are still on par with the 2008/2009 financial crisis.
Yield Curve Control at Work
Rates haven’t just moved higher in the U.S. It’s a global phenomenon. Most central banks ruminated out loud this week about the fact. The European Central Bank said they stood ready to do what it takes, although its not clear what they meant by that. Fed Chairman Powell said he didn’t plan to tighten policy anytime soon. This had the perverse effect of driving rates higher because it implied he’d be ok with even more inflation.
The central bank in Australia, on the other hand, put their money where their mouth is. They doubled-down on their yield curve control policy by doubling their daily bond purchases to A$4 billion ($3.11 billion) from A$2 billion. Now we’re talking!. This led to the second largest fall in 10-year yields since 2002.
A template for other central bankers if rates move too far too fast? We shall see.
It’s All About Supply & Demand
The narrative of late has become the following: rising rates = lower stock prices. Narratives can be wrong of course. If you look at the historical data the reverse seems to be true.
Typically, stocks do well during rising rate periods because it means growth is picking up which usually equates to an improved earnings picture. Be that as it may, human emotions over the short-term are driving a couple trades:
– Investors rotating out of government bonds to hedge against rates moving even higher. Pretty straight forward.
– The other is a little more convoluted. Growth stocks have taken it on the chin.
Why is that? A lot is made of the fact that growth stocks are long duration assets, meaning their valuations are very dependent of cash flows deep in the future. Increase the discount rate and present values go down.
But the other factor at play in the growth universe is simple supply and demand. Aggressive growth managers pulled in a ton of money last year. Take Cathie Wood at ARK Investment Management. Her firm pulled in ten’s-of-billions last year, and all the money went into the most aggressive growth names out there.
However, this year the narrative has shifted to rising rates = bad for high valuation growth stocks. Enough people believe it and it becomes a self-fulfilling prophecy = assets flow back out, as you can see below.
Her funds are forced sellers in a weak market, and she holds concentrated positions in a number of stocks.
Anytime you own 10%, 20%, or 30% of the outstanding shares of a company you are stuck. There isn’t the liquidity to get out. So, she is forced to sell the more liquid names (think all the large-cap growth stocks). Selling begets selling over the short-term and it feeds on itself. Is it caused by higher rates? Maybe in a way, but if it wasn’t rates, it probably would have been some other reason.
Did this cycle end on Friday? One of the Ark ETFs was down over 8% at one point today before bouncing to close down just 0.8%. Time will tell.
Charts We Found Interesting
1. Are we poised for a fourth wave? Or is the current vaccination rate getting ahead of things?
2. It is staggering how much money has gone into bonds since the financial crisis.
3. The U.K, became the first economy to promise to raise taxes. Rishi Sunak’s new budget includes an increase in corporate taxes from 19% to 25% in 2023. A lot can happen between now and then, though.
4. How far the minimum wage went in 1968 versus today.
5. Mining Bitcoin uses a lot of energy. How much? A little more than Argentina.
6. Where have all the houses gone?
7. The million-dollar question – will inventories start to pick up now that mortgage rates are on the rise?
8. We thought COVID and working from home would lead to a baby boom. As it turns out, it has led to a baby bust, at least in Italy. Who would have thought??
Have a good weekend.
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