Dow futures drop over 300 points as bond yields continue to rise

Lloyd Doyle
February 6, 2018

If Mr Powell, a Trump appointee, decides to hold back on rate rises, in order to protect market investors and keep his boss happy, he may merely be delaying the inevitable. It's sowing extreme angst in USA equities, which last week fell the most in two years.

Sure enough, bond yields hit a four-year high Friday. Here are some thoughts on why that can be bad for equities. The S&P 500 is down nearly 8% from its all-time high.

The Dow Jones Industrial Average fell almost 1,600 points for its biggest intraday drop in history in points terms, or more than 6.0 percent, before ending down 1,175.21 points, or 4.6 percent for its biggest one-day fall since August 2011.

The Dow Jones Industrial Average fell 1,175.21 points, or 4.6 percent, to 24,345.75, the S&P 500 lost 113.19 points, or 4.10 percent, to 2,648.94 and the Nasdaq Composite dropped 273.42 points, or 3.78 percent, to 6,967.53.

Another way of thinking of this is to consider valuation multiples for each security. The second component is the difference between the TIPS yield and the nominal Treasury yield. That compares with 22.6 times profits for the S&P 500.

"We have an environment where interest rates are rising".

Again, the comparison, a version of something known as the Fed model, isn't unanimously embraced by professionals.

Offshore fund managers have traditionally invested in NZ bonds as a straight yield enhancement on US Treasury Bonds.

The market's slump began on Friday as investors anxious that creeping signs of higher inflation and interest rates could derail the market's record-setting rally.

"The simplest way to look at it is, everything is relative". Therefore, we do not need to offer such a big risk premium to come into NZ bonds.


A related concept is net present value. Partly that's because we never played the money printing game and until last week, our market interest rates were much higher than the United States, and most other developed nations. That's a measure of how much a stock costs relative to how much that company has been making in profits.

Rising bond yields means higher borrowing cost for companies and an alternative investment option for traders. This also serves as an indicator of sorts, showing the markets move away from bonds as rates rise.

"Here is why markets dropped [last] week", says Mr. Sebag. "The links are always tenuous and squishy at best".

The S&P500 returned 5.7% in the month on the way to fresh record highs, which lifted the return over one year to 26.6%. "The pullback is likely to be just an overdue correction, with say a 10 percent or so fall, rather than a severe bear market - providing the rise in bond yields is not too abrupt and recession is not imminent in the USA with profits continuing to rise".

"Last year, you had $200bn-a-month going into the market from the European Central Bank (ECB) and Bank of Japan (BoJ), which suppressed bond yields, however this year it will average around $60bn".

But there's a point where the "signal" leaves the abstract and becomes a drag on earnings. On the downside, stock prices probably won't be as insanely good. Looking at days last week, a rally that looked bulletproof around noontime Wednesday fell to pieces after policy makers added one word - "further" - to their outlook for the pace of tightening. Given the US Federal Reserve's balance sheet run-off and the European Central Bank's expected taper by end of 2018, global liquidity will turn from an expansionary flow to a contractionary flow by Q4 2018. Traders are rushing into the safety of bonds amid the selling, pushing yields in the belly of the Treasury curve down more than 10 basis points. The correlation between German and USA 10-year notes stands at north of 0.6.

World equity markets are taking their cue from the turnaround in global bond markets. Buying a house gets more expensive, credit cards bite harder, consumer confidence takes a hit.

"The market has had an incredible run", said Michael O'Rourke, chief market strategist At JonesTrading In Greenwich, Connecticut.

Furthermore, the Federal Reserve - in Janet Yellen's final meeting as chair - was more hawkish than in previous meetings, increasing the likelihood of an interest rate rise in March. The firm manages US$179 billion. Then, over the past couple years, middle-class wages finally started to recover and economic growth was solid - but inflation was still nowhere to be seen. The market downturn isn't being driven by bad economic news.

Other reports by Iphone Fresh

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