Stocks defying bond-market danger put Wall Street on notice

For all the threats out there, stocks this week were barely feeling the fear as developed world markets rallied back to levels seen before Russia’s invasion of Ukraine a month ago. That’s even as Treasury yields broke out anew and key sections of the bond curve signalled economic trouble.

As the Fed embarks on an aggressive path of policy tightening, it looks like something may have to give. Strategists at Mizuho International Plc are among those warning risk assets – and eventually economic growth – won’t be able to resist the heavy pull of a higher discount rate.

Yet a growing number of money managers are betting equity indexes have already largely priced in bearish bond moves, while all signs suggest the US economy remains in decent health. “Judging from the performance of risk assets, markets seem to believe such levels will not trigger a recession and hurt risk assets,” said Janet Mui, head of market analysis at Brewin Dolphin Ltd. “I think there is a degree of complacency there.”

Real yields, a key driver for cross-asset valuations, point to the growing dissonance. These inflation-adjusted yields are rising, a reason in theory for investors to pare exposures to richly valued high-growth equities whose profit potential lies in the future. Yet the opposite is happening.

Bloomberg

The Wells Fargo basket of software-heavy stocks has rallied almost 20% since March 16, the start of the Fed’s rate-hiking cycle. That’s as benchmark US real yields have surged toward a level that sparked a selloff in January.

Wall Street investors may be desensitised to the latest Treasury machinations this time round, while healthy earnings-growth expectations suggest a buoyant economy. “Investors are now looking more to a future where real yields are higher, nominal yields are higher, but not so much that it is worth selling more equities at these levels,” said Luke Hickmore, investment director at Abrdn.

Technical factors may be playing a role. According to JPMorgan Chase & Co. strategists, pension and sovereign wealth funds have already deployed as much as $230 billion to stocks to meet allocation targets. Now that those moves have played out, strategist Nikolaos Panigirtzoglou says equities look vulnerable.