Rising Yields, Inflationary Pressures, and What They Mean for the Markets Moving Forward

We’ve spoken frequently about bond yields, government debt, and inflation recently, and warning signs are continuing to accumulate. Yields are marching higher—especially along the long end of the curve—as investors grow optimistic about economic growth and increasingly wary of rampant future inflation. In February, the 10-year UST had its largest gain in four years and climbed above 1.5% yesterday to hit a one-year high—putting it above the S&P 500^® Index dividend yield. 2020 was an unprecedented year for equity performance, but can that continue as yields climb and begin to offer an attractive, lower-risk alternative? It’s worth keeping an eye on, as all major U.S. indices closed down yesterday. Fed Chair Jerome Powell attempted to calm inflationary fears in testimony this week, but the market continues to brace itself for newly unleashed price pressures. Meanwhile, government stimulus sent the M2 money supply soaring by over $4 trillion and powered a significant spike in bank deposits and personal savings—both of which could add fuel to the inflation fire. But how exactly is the ~$27 trillion of U.S. government debt going to get paid off? And what about climbing commodity prices and inflated equity valuations? The situation is evolving and Powell is confident in the Fed’s power to calm the waters, but we’ll certainly be looking for any additional indicators of what may lie ahead.

1. The age-old adage “Don’t fight the Fed” is being tested. The markets know the Fed can’t keep a lid on near-zero rates forever. Between the new debt created by the stimulus packages, our debt to GDP, the massive amount of corporate and other debt issued in the past few years, and the heating up of much of the economy (the good half of the Covid-factor), investors are positioning/adjusting accordingly.

On the equity side, rising interest rates are beginning to compete with dividend yields and are starting to affect equity valuation models. After an unprecedented run, the stock markets are due for a rest. The question remains, how big of a rest?

Source: The Daily Shot, from 2/26/21

2. What is the saying? “Bond yields don’t matter until they do”…

Source: The Daily Shot, from 2/25/21

3. For reference, some longer duration bonds are approaching bear market territory.

Source: The Daily Shot, from 2/26/21

4. To wit, the 10-year UST now yields more than the dividend yield of the S&P 500:

Source: The Daily Shot, from 2/26/21

5. Has the market become “addicted” to artificially low rates? Below are current market expectations for Fed rate hikes. Will a 1% rise in the cost of debt actually change investor behavior?

Source: Bloomberg, from 2/26/21

6. A $4 trillion increase in the money supply is “sloshing around” trying to find a home. This is certainly setting an inflationary environment!

Source: The Daily Shot, from 2/26/21

7. The Covid-induced inability of Americans to spend on travel and vacations, dining and other leisure activities, combined with much of the stimulus package going into savings, has caused a spike in bank deposits. Will this “fuel” allow consumers to accelerate spending post-Covid?

Source: The Daily Shot, from 2/25/21

8. This should be good news for emerging markets whose economies are largely based on commodity production…

Source: The Daily Shot, from 2/25/21

9. An interesting correlation. Does the U.S. equity underperformance cause the dollar decline or does the declining dollar weaken U.S. equity relative to the MSCI World ex-U.S.?

Source: The Daily Shot, from 2/25/21

10. The S&P 500 equal weight index, after years of underperformance due to the tech & communication surge, has finally caught up to its market-cap-weighted brethren. Will this trend continue?

Source: The Daily Shot, from 2/25/21

11. Excess market valuations are prevalent. Is Tesla really worth more than the world’s top ten car manufacturers combined (by both sales and units)?

Source: The Daily Shot, from 2/26/21

12. What is the big deal about Reddit and the small investor crowd taking on the shorts? Just ask all the investors who bought above $100, $200 or $300! Is the latest spike a redux?

Source: The Daily Shot, from 2/25/21