This week wraps up an event that investors have been waiting for all summer - the FED's Economy Summit at Jackson Hole, WY. In his speech, FED Chairman Jerome Powell delivered 3 important market-awaiting news: i) tapering will begin this year (although pace unknown); ii) continues to view inflation as transitory and iii) reassure that interest rates will remain low until substantial further progress has been made. 

i) Although tapering is not good news for the market, because it means FED is not printing as much money, one could argue that market has been anticipating this news for the entirety of this year, when low-quality stocks got hit earlier this year and are still at depressed levels.

ii) We view that market has also been pricing in inflation. Low-quality growth stocks continue to stay at depressed levels, while industries where inflation hurts their profits are not being loved by the market either. 

iii) This is as anticipated, but be careful, is something that market has not been pricing this in. Currently, the consensus is for an initial rate hike at the end of 2022. Raising interest rates will undoubtedly hurt the stock market, and our view is that market will start to price in this risk early to mid next year. 

With September - November season coming, seasonally a week period for the stock market, we advise clients to be even more cautious. Investors should try not to be complacent, and always be prepared to weather a 5-10% correction, which is very imminent. Take a look at this time of year from last year, the indices overshoot and then had a ~10% correction in a matter of days, catching investors off guard.

In today's post, we would like to direct clients to our analysis of 10 Year Treasury Yield: where this can go, and how to position our portfolio going into year's end.  

10 Year Treasury Yield

Fundamentally, we believe when the FED starts to taper, bond yield should go higher. Let's take a look at what happened historically in 2013. 

This time it can be different from 2013. Quantitative Easing (QE) was only introduced by the FED after the 2008-2009, and arguably this was the stimulus that propped up the market from the depth of the recession until 2013. When the FED talked about removing that stimulus (i.e taper), the market naturally would freak out, hence the phenomenon/ market reaction termed "taper tantrum." However, after the initial tantrum, stock market realized tapering is not the end of the world, the economy could do well on its own, and therefore market continued to go up.

2021-2022 is different because market understands how tapering works (lesson learned from 2013), market has been pricing in a potential tapering this year or next year, and the FED has recently prepped the market for tapering. If you read the stock market price tape on Friday 27th Aug 2021, you will see that after Chairman Powell said tapering will begin end of this year, market went up substantially.  

Now let's take a look at the chart of the 10 year treasury yield below. It broke out of the 1.10% level early 2021, made the high of nearly 1.8%, pulled back and made a double bottom off of the 1.10% level. If you draw a trendline depicting the downtrend that the 10YR Yield has been under, you can see that it has broken out of that trendline, retested the breakout successfully, and now heading higher.

What does higher 10Yr Yield mean for stock market?

Our first instinct thinks that a higher yield will definitely hurt low-quality, expensive growth, the not-yet profitable type we have been trying to avoid. Remember, a higher yield eats away from the future valuation of these companies.

Banks/ Financials

Secondly, we think that a higher yield will help the banks/financials. Below are charts of Bank of America and Citi Group, two big banks whose businesses rely heavily on lending, which make them more profitable if rates go higher. We plotted the charts of BAC and C as candlesticks, along with the move of the 10Yr Yield in blue solid line. Underneath the plots are correlation coefficients (CC): a positive and close to 1.0 CC indicates the moves of the stock of interest and the 10Yr Yield are correlated - likely that when one moves up, the other is seen moving up too.

You can see that BAC and C have relatively high CC with the 10Yr Yield. Also, the charts of BAC and C indicate they are likely to be breaking out as well. 

Industrials

Let's examine Boeing, the biggest industrial stock that we have. We think there is also a good correlation here with the 10 Yr Yield, and if the 10 Yr Yield goes up, it is reasonable to predict Boeing will follow as well.

Technology

Before we go further, we want you to see what the CC looks like for technology stocks. Remember, growth/tech stocks trade heavily based on future earnings, hence the term growth. Higher yield eats away from those future earnings, thus hurting the stock's valuation. We're picking Apple for you to examine as an example. Look from the beginning of this year, you will see that the majority of times Apple has a negative, close to -1.0 correlation coefficient with the 10Yr Yield. When 10 Yr Yield moves up, Apple price moves down, and vice versa. 

We think if 10 Yr Yield makes a move higher to earlier's high of 1.7%, Apple will likely make a move lower to recent lows. However, analysts are thinking 10Yr Yield are heading to 1.45%, a rate viewed as goldi-locks, when the stock market could perform well.

Ford and General Motors

Finally, let's take a look at two of our biggest holdings: Ford and General Motors. These stocks are categorized as consumer discretionary, meaning it should perform well when the economy is doing well, that is consumers have money to spend.

Take all the time you want to examine the correlation between F/GM and the 10Yr Yield. Overall, the CC is above 0. You can also see that virtually any time yield moves higher, F and GM move higher, and vice versa. The only time F and GM contradicted the 10Yr Yield was in early June, when they were out with very good news from their own. However, the exception didn't happen for long, as both companies went down with the 10Yr Yield.

We believe if the yield heads higher this year, F and GM will head higher as well.