S&P 500 Weekly Earnings Update: The Treasury Market Was Busy This Week - It's The Rate Of Change That Matters

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by: Brian Gilmartin, CFA

The big news this week was the Treasury market and the rise in yields, but more on that in a minute.

With 488 companies having reported Q4 '16 earnings already, there is little left to know, and instead we look forward:

Thomson Reuters data by the numbers (Source: This Week in Earnings dated 3/3/17):

  • Forward 4-Quarter estimate: $131.22 vs last week's $131.43
  • PE ratio: 18(x)
  • PEG ratio: 2.1(x)
  • S&P 500 earnings yield: 5.51% vs last week's 5.55%
  • Year-over-year growth of the forward estimate: +8.49% vs last week's +8.41%

It is always welcome to see the "forward growth rate" (last bullet) tick higher each week, and this week the forward growth rate increased again. However, the big news this week was the rise in Treasury yields, as the 10-year Treasury jumped 17 basis points from 2.32% last Friday to 2.49% as of Friday, March 3 '17.

17 bps is a sizable increase in yield and it came as the probability on a fed funds rate increase from 50 to 75 bps rose from 33% early last week, pre-Dudley's speech, to 90% as of Friday.

No surprise that the sharpest increase in the 10-year Treasury occurred the week of the Presidential election as it rose from 1.78% to 2.12% or a whopping 34 basis points.

The high for this move since November 8th is 2.60%, which occurred mid-December '16. All the technicians are watching 2.60%-2.62% and then 3.02% which was the 2013 high tick and the highest 10-year yield in the last 9 years.

Both the 1-year and 2-year Treasuries traded to 7-8 year highs this week, highs not seen since November, 2008.

Analysis/Conclusion: Higher interest rates have a habit of putting a wet blanket on rising stock prices, however, that wasn't true in 2013, when the S&P 500 rose 32% and the 10-year Treasury yield rose from 2% to 3%. The momentum trade might see some heavy sledding if rates rise rapidly, but rising interest rates are also a sign that the US economy is returning to a more "normal" environment.

There hasn't been any fear of inflation for many, many years, or even heightened "inflationary expectations". Most of the Treasury curve is trading underwater with negative real returns.

2013 was all about the Bernanke "Taper Tantrum" - i.e. faster growth and therefore Ben was going to start withdrawing liquidity, but he got the boot before the end of the year. While many expect higher interest rates down the road, it's the "rate of change" in yields that matter. Actually the long-end seems to be remaining fairly stable.

Client bond allocations within the 60% / 40% portfolio remain in a lot of cash, some global bond funds, and a position in the TBF (unlevered inverse Treasury).

Client's healthcare exposure has increased since January 1 '17, mainly with biotech ETFs like the IBB. The XBI is smaller-cap focused and that hasn't added (yet) nor has the BBH. Health Care was the worst performing sector in 2016, down 3% on the year, versus the 11.96% 2016 return on the S&P 500. Pfizer (NYSE:PFE) has been client's largest Health Care position for years and the only single stock risk outside of a few positions in Merck (NYSE:MRK) and JNJ. The Health Care weighting has been lifted from 3%-5% to close to 10% depending on the client account and the overall objective.

Readers are owed a separate post on Health Care. There has been a lot on the plate.

Client positions continue to reflect the view of "stocks over bonds" in the normal 60%/40% asset allocation portfolio, and Technology and Financials are the two biggest sector weights and overweights, with Technology being the largest overweight.

(Positions can change at any time, and there may or may not be an update on this blog.)

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