Stocks March Higher as Bonds Sink Again

Stop me if you’ve heard this before.  Major stock indices are pushing higher once again even as bond yields rise once again (remember, higher bond yields mean lower bond prices).  The rally is broad based when we look at a sectoral breakdown, though several other measures seem less enthusiastic.  Higher long-term rates might – and should – exert some gravitational pull on stock markets eventually, but they are unlikely to do so in a week that features few external catalysts to dampen equity investors’ enthusiasm. 

Momentum appears to be a key factor at play behind today’s moves in both key asset classes.  Market momentum can be better thought of as trend following, and to my mind, trend following is best thought of as inertia.  I’ve often said that it is useful to think of trend following in terms of Newton’s First Law of Motion, which states:

A body remains at rest, or in motion at a constant speed in a straight line, unless it is acted upon by a force.

Lately, bond yields have risen at a relatively constant speed in a generally straight line, even when seemingly acted upon by a force.  Friday’s employment report could have been, if not should have been, one of those external forces.  As we wrote shortly after:

If you’re a bond investor who relishes economic weakness because it reduces pressure on inflation and biases central bankers towards accommodative policies, then you should have been okay with it. 

The problem is, bond investors were not OK with it.  After initially sinking, 2-year and 10-year Treasury yields each rose by 3 basis points.  To be fair, both instruments did their best to break their downtrends on Thursday, but while 2-year yields remain below their recent highs set last Monday, 5-, 10- and 30-year yields have all resumed their march to multi-year highs today.  The external force was not sufficient to break that inertia.

Stocks, however, decided on Friday to ignore the negative messages sent by the bond market once again and rallied despite the economic weakness revealed in the employment report.  Today, that positive trend remains in place.  The only S&P 500 (SPX) sector trading lower at noon ET was rate-sensitive real estate, and that decline is only marginal.  Indeed, this comes as NYSE advances only slightly outpace declines and the Cboe Volatility Index (VIX) is slightly higher, though the latter can be discounted somewhat because it is rising from an already-low level.

On Friday, I was asked by a reporter about potential catalysts for the week ahead.  There were quite few “known unknowns” to discuss.  The economic calendar is very light and there is a general lull in corporate earnings before JPMorgan Chase (JPM) kicks off the Q3 parade a week from tomorrow (October 13^th).  Thus, unless there is unexpected geopolitical or major company news, it is reasonable to think that the inertia in both markets can continue relatively unabated. 

Certainly, at some point, stock prices should reflect the pernicious effects of higher rates.  They are a drag on stock valuations, which, at least theoretically, are based upon the present value of future earnings, dividends, or cash flows.  Higher rates mean lower present values.  We see that affecting a wide range of stocks in various industries, but investors have decided that the potential benefits of AI make tech stocks somewhat immune from such prosaic factors.  If the profitability of the new technology is perceived to be limitless, then those who might benefit should be willing to pay any price to borrow in order to finance its buildout, and any set of positive numbers can be plugged into that present value calculation.  That’s one of those things that makes sense until, of course, it doesn’t.

Besides, if you’re simply following trends, you are, by definition, saying that valuations are at most a trivial concern – if at all.  If the trajectory is a constant straight line higher and there are few obvious forces that can divert it, then we can and do get days like today.