Stocks may be catching a breather in Monday trading, but the aftershocks from the sharpest bond selloff in almost five decades are set to reverberate across investing strategies hitched to the cheap-money era.
Consider the troublesome cross-asset linkages out there. Technology stocks have become ever-more sensitive to U.S. debt, with co-movements turning the most negative since 1999, according to Bank of America Corp.
Volatile currencies from the Mexican peso to Australian dollar have become more vulnerable to Treasury gyrations. Meanwhile, the short-term link between bonds and the S&P 500 have spiked to the most positive since 2016—signaling the growing threat of concurrent declines across both assets.
As the U.S. experiment with run-it-hot economics spurs the demise of the long-dated Treasury bull market, strategies tied to the low-rate era look dangerous. And that raises the prospect of fresh selling to come.
“The duration heuristic is the most powerful force in the market at present,” Warren Pies, founder of 3Fourteen Research, wrote in a note. “The pandemic—and our collective response to it—has created this situation.”
While the Treasury rout has been taking place for good economic reasons—juicing trades that ride the business cycle—some of the biggest market winners of the past year still look vulnerable.
Take Big Tech. While they have not always shown a positive link with bonds, the likes of Facebook Inc. and Netflix Inc. are by nature long-duration trades. When economic growth plunged in the pandemic, investors bought these equities for their promise of long-term profits discounted at record-low rates.
With the U.S. economy expected to expand at the fastest pace since the 1980s while bond yields are on the rise, the sector has become less attractive—while cyclicals like energy and financials have regained favor.
In fact, U.S. tech stocks are even more vulnerable to higher rates now than during the 2013 Taper Tantrum, when the Federal Reserve signaled a reduction in its asset purchases, BofA strategists led by Andy Pham wrote in a note.
The Nasdaq 100 rose almost 2% in Monday trading as Treasury yields dipped, underscoring the close ties between the two.
All this is a problem for those chasing U.S. large-cap benchmarks where tech is easily the chunkiest sector. It’s also an issue for a classic 60/40 portfolio.
One way of figuring out duration risk in stocks is to invert dividend yields, an indication of how long it would take an investor to recoup their initial investment, other things being equal. By that measure, a portfolio with 60% in the S&P 500 and 40% in Treasuries would have highest duration in some two decades, according to Jeroen Blokland.
“Equity duration has steadily increased over the last decade as the weight of technology stocks, very high duration stocks, has risen to all-time highs,” the Robeco portfolio manager wrote on the asset manager’s website. “As a result, portfolio duration has increased as well, as both bond duration and equity duration have spiked.”