Yield Curve Catching Up
Around the world bond yields have risen rapidly after hitting record lows in early 2020. In the U.S., the 10-year Treasury bond has tripled from about 50 basis points to 1.5%. The ascent into early March was the largest six-month appreciation since 1970. The 10-year – 3-month yield spread now stands close to 150 basis points, marking the steepest yield curve since 2018.
The rapid rise in yields has led to steep corrections in certain parts of the equity and fixed income markets. Rates appear to be the straw that broke the back of high-flying technology and momentum equities. Since hitting highs in February, the Nasdaq Composite and S&P 500 Momentum Indexes declined 7% and 10.7%, respectively. Investors are rotating into value and pro-cyclical sectors. The Value Line Geometric Index is up over 8% year-to-date. Financials and Industrial sectors are up 18% and 13%, respectively.
Bond prices have fallen across the spectrum. Long-duration corporate bonds have endured a rough start to the year with the ICE BofA US Corporate AAA 15+ Index down over 11%. Near- and mid-term bonds have fared better but have still experienced outsized declines.
While these corrections are unnerving for some investors, the steepening curve and shift from technology and momentum stocks to financials and cyclicals should offer increased confidence in the economic outlook. Put simply, the yield curve is playing catch up to the mounting evidence that the recovery is on more solid footing. The yield curve lagged and stayed unusually flat even as the economy and financial markets rebounded throughout last year. As Table 1 shows, the only time a similarly suppressed yield curve was observed one year after the prior cycle’s peak was during the early ‘80s double-dip recession. Now, the steepening yield curve is signaling that the probability of a double-dip recession in the U.S. has fallen.
TABLE 1. NBER BUSINESS CYCLE PEAK DATES AND 10-YEAR/3-MONTH SPREAD ONE YEAR LATER
|
NATIONAL BUREARU OF ECONOMIC RESEARCH BUSINESS CYCLE PEAK DATE |
10-YEAR/3-MONTH SPREAD ONE YEAR LATER |
|---|---|
| JANUARY 1980 | -2.77% |
| JULY 1981 | 1.26% |
| JULY 1990 | 2.50% |
| MARCH 2001 | 3.21% |
| DECEMBER 2007 | 2.67% |
| FEBRUARY 2020 | 1.01% |
SOURCE: NBER, FACTSET, GENERATION IACP INC.
The correction in fixed income has created investment grade bond opportunities with yields approaching 3%, making them relatively attractive since the brunt of the resurgence in long-term rates has likely already occurred. In past cycles, the 10-year and 3-month spread widened to 4% (Chart 1). We would be surprised to see this occur in this current atypical cycle. The hangover of massive fiscal and monetary stimulus unleashed to combat the economic consequences of COVID-19 and the debt and deficits taken on by numerous countries around the world will likely slow the ascent of long-term rates from here.
CHART 1. 10-YEAR AND 3-MONTH SPREAD SINCE 1970
SOURCE: FACTSET, GENERATION IACP INC.
Equities remain expensive and high quality, undervalued names are scarce. As we wrote in Expectations Running High, the biggest risk at this juncture is valuation; stock prices already reflect the economic rebound that the yield curve is now signaling. The rise in yields has been positive for our banking and insurance holdings. These companies will benefit from an interest rate tailwind after struggling with declining rates for years. Acquired below or at slight premiums to book value, these stocks still trade below their fair market values. And if rising rates continue to punish the technology and momentum stocks, we will seek out high-quality technology companies that sell off unduly.
RJ STEINHOFF, CFA
HEAD OF RESEARCH
DISCLAIMER
The information contained herein is for informational and reference purposes only and shall not be construed to constitute any form of investment advice. Nothing contained herein shall constitute an offer, solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. Investment accounts and funds managed by Generation IACP Inc. may or may not continue to hold any of the securities mentioned. Generation IACP Inc., its affiliates and/or their respective officers, directors, employees or shareholders may from time to time acquire, hold or sell securities mentioned.
The information contained herein may change at any time and we have no obligation to update the information contained herein and may make investment decisions that are inconsistent with the views expressed in this presentation. It should not be assumed that any of the securities transactions or holdings mentioned were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities mentioned. Past performance is no guarantee of future results and future returns are not guaranteed.
The information contained herein does not take into consideration the investment objectives, financial situation or specific needs of any particular person. Generation IACP Inc. has not taken any steps to ensure that any securities or investment strategies mentioned are suitable for any particular investor. The information contained herein must not be used, or relied upon, for the purposes of any investment decisions, in substitution for the exercise of independent judgment. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. We make no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained herein. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained herein.
All products and services provided by Generation IACP Inc. are subject to the respective agreements and applicable terms governing their use. The investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. Nothing herein shall constitute an offer or solicitation to anyone in any jurisdiction where such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation.
Around the world bond yields have risen rapidly after hitting record lows in early 2020. In the U.S., the 10-year Treasury bond has tripled from about 50 basis points to 1.5%. The ascent into early March was the largest six-month appreciation since 1970. The 10-year – 3-month yield spread now stands close to 150 basis points, marking the steepest yield curve since 2018.
The rapid rise in yields has led to steep corrections in certain parts of the equity and fixed income markets. Rates appear to be the straw that broke the back of high-flying technology and momentum equities. Since hitting highs in February, the Nasdaq Composite and S&P 500 Momentum Indexes declined 7% and 10.7%, respectively. Investors are rotating into value and pro-cyclical sectors. The Value Line Geometric Index is up over 8% year-to-date. Financials and Industrial sectors are up 18% and 13%, respectively.
Bond prices have fallen across the spectrum. Long-duration corporate bonds have endured a rough start to the year with the ICE BofA US Corporate AAA 15+ Index down over 11%. Near- and mid-term bonds have fared better but have still experienced outsized declines.
While these corrections are unnerving for some investors, the steepening curve and shift from technology and momentum stocks to financials and cyclicals should offer increased confidence in the economic outlook. Put simply, the yield curve is playing catch up to the mounting evidence that the recovery is on more solid footing. The yield curve lagged and stayed unusually flat even as the economy and financial markets rebounded throughout last year. As Table 1 shows, the only time a similarly suppressed yield curve was observed one year after the prior cycle’s peak was during the early ‘80s double-dip recession. Now, the steepening yield curve is signaling that the probability of a double-dip recession in the U.S. has fallen.
TABLE 1. NBER BUSINESS CYCLE PEAK DATES AND 10-YEAR/3-MONTH SPREAD ONE YEAR LATER
|
NATIONAL BUREARU OF ECONOMIC RESEARCH BUSINESS CYCLE PEAK DATE |
10-YEAR/3-MONTH SPREAD ONE YEAR LATER |
|---|---|
| JANUARY 1980 | -2.77% |
| JULY 1981 | 1.26% |
| JULY 1990 | 2.50% |
| MARCH 2001 | 3.21% |
| DECEMBER 2007 | 2.67% |
| FEBRUARY 2020 | 1.01% |
SOURCE: NBER, FACTSET, GENERATION IACP INC.
The correction in fixed income has created investment grade bond opportunities with yields approaching 3%, making them relatively attractive since the brunt of the resurgence in long-term rates has likely already occurred. In past cycles, the 10-year and 3-month spread widened to 4% (Chart 1). We would be surprised to see this occur in this current atypical cycle. The hangover of massive fiscal and monetary stimulus unleashed to combat the economic consequences of COVID-19 and the debt and deficits taken on by numerous countries around the world will likely slow the ascent of long-term rates from here.
CHART 1. 10-YEAR AND 3-MONTH SPREAD SINCE 1970
SOURCE: FACTSET, GENERATION IACP INC.
Equities remain expensive and high quality, undervalued names are scarce. As we wrote in Expectations Running High, the biggest risk at this juncture is valuation; stock prices already reflect the economic rebound that the yield curve is now signaling. The rise in yields has been positive for our banking and insurance holdings. These companies will benefit from an interest rate tailwind after struggling with declining rates for years. Acquired below or at slight premiums to book value, these stocks still trade below their fair market values. And if rising rates continue to punish the technology and momentum stocks, we will seek out high-quality technology companies that sell off unduly.
DISCLAIMER
The information contained herein is for informational and reference purposes only and shall not be construed to constitute any form of investment advice. Nothing contained herein shall constitute an offer, solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. Investment accounts and funds managed by Generation IACP Inc. may or may not continue to hold any of the securities mentioned. Generation IACP Inc., its affiliates and/or their respective officers, directors, employees or shareholders may from time to time acquire, hold or sell securities mentioned.
The information contained herein may change at any time and we have no obligation to update the information contained herein and may make investment decisions that are inconsistent with the views expressed in this presentation. It should not be assumed that any of the securities transactions or holdings mentioned were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities mentioned. Past performance is no guarantee of future results and future returns are not guaranteed.
The information contained herein does not take into consideration the investment objectives, financial situation or specific needs of any particular person. Generation IACP Inc. has not taken any steps to ensure that any securities or investment strategies mentioned are suitable for any particular investor. The information contained herein must not be used, or relied upon, for the purposes of any investment decisions, in substitution for the exercise of independent judgment. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. We make no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained herein. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained herein.
All products and services provided by Generation IACP Inc. are subject to the respective agreements and applicable terms governing their use. The investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. Nothing herein shall constitute an offer or solicitation to anyone in any jurisdiction where such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation.
