The S&P 500 is trading in record-territory range, which is above 3,800, as investors are emboldened by strong quarterly earnings reports among banks, President Biden’s $1.9-trillion stimulus spending plan, and hopes of great progress in distributing COVID vaccines.
The same sunny outlook has raised yields on 10-year U.S., treasury bonds from 0.9 percent at the end of December to 1.1 percent last week.
Rising bond rates can make stocks, which are inherently more risky, less attractive, but they continue to climb relentlessly.
Tech stocks have been particularly sensitive to rising interest rates in the past but currently remain among Wall Street’s best performers.
The bond market’s unusual behavior “is all about inflation expectations rising well above pre-outbreak levels,” Wall Street Journal economics reporter Jon Sindreau explained in the paper’s 23 January edition.
“The market is now convinced that, even if the Fed eventually raises rates, it will do so by less” than the rate of inflation, “keeping financial conditions very loose,” he contended.
The economic crisis has kept inflation in check, but analysts expect it to rise sharply later in the year as vaccines are widely taken and the U.S. economy shows signs of a steady recovery.
Normally, the Fed would raise rates pre-emptively to tamp down inflation before it flares up. Last year, however, Fed officials announced they would allow inflation to range above their 2-percent target, at least for brief periods, before adjusting rates.
When inflation is speeding up, stocks tend to outperform bonds, whose fixed interest rates make bonds less valuable as inflation robs money of its value.
If the Fed keeps interest rates below the rate of inflation, bonds’ value will be protected, Sindreau said.
When prices inflate, energy companies, miners, and retailers tend to benefit; tech stocks, utility firms, and other businesses seen as “bond proxies” don’t perform as well.
Still, shares of tech and telecom companies can outperform the stock market even as bond yields rise “as long as ‘real’ yields remain subdued,” Sindreau noted, citing market data back to 2004.
Usually, bank shares and stocks of other companies that tend to ride the crests and valleys of economic cycles perform well in an economic recovery. These cyclical stocks, however, “may struggle more than previously thought if inflation-adjusted yields stay low,” he said.
TREND FORECAST: We maintain our forecast for Dragflation: the economy will sink into the “Greatest Depression” but prices of goods, services, and commodities will rise.
Prices will not rise because of supply and demand, since, as with oil, for example, there will be more supply than demand. Prices will rise because the value of currencies will decline as central banks devalue them by printing trillions to “stimulate” sagging economies. Thus, the cheaper the currency, the more it costs to buy products.
Gold and silver will continue as the most precious metal safe-haven assets. We maintain our forecast of new rounds of artificial central bank monetary stimulus and massive amounts of government fiscal stimulus that will artificially prop up equity markets and economies.
