- Real yields (inflation adjusted) are marginally positive making bonds a viable asset class for investment.
- A peak in long-term yields would be supportive of stock prices.
- Earnings growth is another buffer and its strength is being understated due to Amazon results.
- Depressed investor sentiment could be a springboard for a market recovery in the second half of the year.
- This idea was discussed in more depth with members of my private investing community, The Portfolio Architect. Learn More »
A welcomed rally in the final hour of trading yesterday turned what looked like another midday meltdown into a sigh of relief. Stocks finished higher across the board, led by the technology sector. It was all the more impressive considering that the 10-year Treasury yield finally eclipsed 3% for the first time since December 2018. Higher long-term yields have been a major headwind for growth stocks in general and technology names in particular this year, so why the rally? I think the consensus of investors believe we may have seen an intermediate-term peak in rates after the torrid run up of more than 100% from the beginning of the year.
The benefit for fixed-income investors is that real yields are marginally positive again. The real yield is the nominal yield of 3% minus long-term inflation expectations, which have been negative since the onset of the pandemic. Positive real yields make segments of the bond market attractive again and also create competition for stocks, but not yet in a meaningful way. I would still rather own a stock that is reasonably valued with a dividend yield close to 3% than a bond yielding 3%, but the rise in rates has created opportunities in some segments of the fixed-income markets that we have not seen since 2018. I think short- to intermediate-term corporate bonds and preferred securities now present good value.
The fact that bonds are now a viable asset class for investing may be one factor in limiting any further increase in yields, which is important considering that the Fed is about to launch its quantitative tightening program through which it will be dumping up to $60 billion in Treasuries on the market each month. The 10-year Treasury yield nearly doubled from 1.37% to 2.6% during the second half of 2016 in anticipation of the last QT program that ran from 2017 -2018, but that was the majority of the upward move. The peak came two years later at 3.25%.
A peak in long-term yields would help support stock prices along with the fact that we have already had a significant drawdown in advance of the Fed’s next rate hike on Wednesday afternoon. Additionally, corporate earnings continue to surprise to the upside, which is another buffer. In fact, profit growth is a lot stronger than the headline number suggests because of one megacap technology name. Amazon (AMZN) fell short of expectations last week, reporting a loss of $7.56 instead of a gain of $8.35, which can largely be attributed to a loss on its investment in EV-maker Rivian Automotive. Sales growth has also slowed relative to what it was during the pandemic when consumers spent more time at home.
The bottom line is that one very large company reduced the earnings growth rate for the entire index from 10.1% to 7.1%. Therefore, there are plenty of high-quality stocks in various sectors that are meaningfully outperforming expectations in a very difficult macroeconomic environment, and that is where investors should be focusing.
Yet disappointments like Amazon are what has driven investor sentiment to levels we have not seen since the Great Financial Crisis in 2009. That is why I see meaningful upside in today’s market during the second half of this year.
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This article was written by
Lawrence Fuller has been managing portfolios for individual investors for 30 years, starting his career at Merrill Lynch in 1993 and working in the same capacity with several other Wall Street firms before realizing his long-term goal of complete independence when he founded Fuller Asset Management.
He is the leader of the investing group The Portfolio Architect, which focuses on an overall economic and market outlook that complements an all-weather investment strategy designed to produce consistent risk-adjusted market returns. Features include: Portfolio construction guidance, access to an “All-Weather” model portfolio and a dividend and options income portfolio, a daily brief summarizing current events, a week ahead newsletter, technical and fundamental reports, trade alerts, and 24/7 chat. Learn More.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed by will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.
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