–Tuesday September 28, 2021 showed us a very predictable market reaction to No New News, save greater conviction that inflation may not be that transient and rates will be going up.
–Market participants (including their computers) have been conditioned by the media to react in this way over decades and there is no nuance with the media. Higher rates and inflation are always bad.
–The ETF-ization of the market only exacerbates these moves.
–A simple examination of the facts will be helpful in settling your nerves.
–Why a move to a 2% or 3% yield on the 10-year Treasury will not spell doom for the market .
This Market Rout Was Very Predictable
All you had to do was pay attention to the yield on the 10-year US Treasury note. From the close last Thursday at a 1.3% yield it had climbed to approximately 1.49 % on Monday’s close and rocketed to a 1.57% yield early Tuesday. As of this writing it is trading at 1.527%. Nothing will spook a market faster than a spike in this very visible and important rate.
Then we had Fed Chair Powell admitting in In his Q and A with the Senate that inflation may be a tad bit more pesky than his earlier comments about it being ‘transient’. And if Powell’s backtracking on inflation were not enough to knock the legs out from under the market conditioned to fear inflation and the interest rate hikes that will fallow, Treasury Secretary Yellen highlighted another worry in her testimony pointing out the risk of a US default if no increase in the debt ceiling were approved by October 18 … the perfect storm. There was no new news here. Most reasonable people (at least people somewhat familiar with the workings of the economy and Congress) already expected that inflation and interest rates would normally increase and a debt ceiling increase or workaround will occur.
The tech/innovation stock rout that continued yesterday into today was very predictable, as the group has been on a rampage for the last few years and is very over-extended. High growth, high PE stocks are more vulnerable to higher rates and an improving economy than those more mundane stocks left behind in recent years (anything small and/or economically sensitive). There appears to be a major rotation going on between these two vastly different investment classes with momentum shifting to the ‘also-rans’.
Many market participants believe otherwise
Why? They (and as a result their computers) have been trained by a media, able to find the darkest lining in every silver cloud, that inflation and interest rate increases are always negative, leading us down the road to our next economic calamity. Why are they so adept at finding these dark clouds? Bad news sells! There is no nuance here. Higher inflation and higher rates are always bad. I believe this to be a major fallacy.
Computerized trading and ETF-ization exagerate these trends
Remember the concept that there is no nuance in the “inflation bad, higher interest rates bad” call. One simple way to trade the market is using exchange traded funds (ETFs). If you don’t want to watch the news wire yourself, you can program your favorite computer to do it for you. If a bit of news that the computer is programmed to trade on pops up, that computer can act (buy or sell) on the user’s behalf putting through trades in stocks or ETFs, all of this while he or she naps.
Because of the popularity of ETFs as vehicles in the market (SPY– SPDR S&P 500 ETF trust) or in a sector (XLF–Energy Select Sector Fund) they are a preferred vehicle for the computer and those wishing instant diversification. They provide an investor the ability to move large (or small) amounts of capital into or out of the market quickly and conveniently.
However, As I said, there is no nuance on the actual background of the headline nor is there any nuance on what is being bought and sold. If you sell $1 million worth of SPYs into the market, you are selling fractional interests in 500 different stocks. Yesterday certain bank and energy stocks sold off on the basis of negative algorithms on inflation and interest rates rising for stocks, even though if this happens it would be a positive for both groups mentioned above.
In a recent weak period for energy prices exploration and production companies and integrated oil companies got hit, somewhat rationally, because lower prices would equate to lower prices for their production assets. At the same time Master Limited Partnerships /midstream companies (MLPs) took a hit even though this was not a problem for them. They are conduits charging a fee to move energy products. Even though they are conduits MLPs are included in broad ETFs that specialize in energy. Energy price are volatile. When the price oil swings down $10 the midstream companies will be crushed, even though the price move (one way or another) will have little bearing on their fundamentals. The ETF mechanism routinely allows the baby to be thrown out with the bath water.
A nuance, the facts, will settle your nerves
The nuance is this-there are two reasons rates and inflation would increase.
One is bad to a degree and that occurs when the Fed taps on the brakes of the economy by raising rates to slow things down, prevent overheating. That is not the case here. The other is when the economy strengthens, demand is strong and the earnings picture brightens … a good time to own stocks. Investors sell defensive bonds, putting upward pressure on their yields, and redeploy that money into assets that appear to have better return potential. I said the former is bad to a degree. The positive is that the Fed is being proactive trying to tamp down potential accelerating inflation before it runs too far (not an easy task) but after years of the on-again/off-again worries about disinflation in the global and US economy this should now be something where we can all breath a sigh of relief. The average individual or computer has not been programmed in this manner by a media that is slim on perspective and full-figured on fear.
One final important point–We have the rates that exist today because of emergencies that occurred 12 years ago and 18 months ago. THESE EMERGENCIES NO LONGER EXIST! RATES SHOULD BE HIGHER!
In light of the above examination of the facts I do not believe despite the expert and genius perpectives of the likes of Joe Kernen and Rick Santelli, that a 2%or even 3% 10-year treasury note will derail our secular bull market. What we are seeing now is a healthy rotation and broadening in the market. In my mind the bloodbath of the past few days is “much ado about nothing.”
What’s your take?