Stocks fell hard last Tuesday as US 10-year bond yields topped 3 per cent for the first time since 2014. There's been much agonised commentary as to what this oft-described "psychologically important level" might mean for equity returns, but is this endless focus misplaced? Rising bond yields hurt the Tina argument, the idea there is no alternative to stocks in a low-yielding world. However, annualised returns of 3 per cent over the next decade is hardly likely to tantalise investors. After all, only an "inveterate stock bear" would argue the S&P 500 won't do better over that period, says DataTrek Research's Nicholas Colas. But investors might be tempted to opt for the safety of bonds over shorter term horizons. One-year US bonds hit 2.2 per cent last week; two-year bonds exceeded 2.5 per cent for the first time since 2008. "If I offered you a no-fee, risk-free contract to deliver a 2.5 per cent annual return on the S&P over the next two years, would you take it?" asks Colas. Yes, it's much lower than historical returns, but it beats inflation and there's no risk of a sharp drawdown.
That may tempt those looking to reduce risk after a nine-year equity bull market, and may explain why investors pulled $868 million (€717 million) out of US equity funds over the last month while adding $5.2 billion into bond funds with a duration of less than three years. There’s nothing apocalyptic about 10-year bond yields near 3 per cent. Rather, investors may be better advised to keep a closer eye on rising short-term yields.
Earnings: after the pop, the drop
Google parent Alphabet last week reported earnings that beat expectations. Shares initially popped higher only for the stock to then suffer its biggest one-day fall in over two months – a pattern that has exemplified US earnings season. Some 80 per cent of companies have topped expectations – the highest beat rate in at least 19 years, notes Bespoke Investment. However, surging earnings haven't supported stock prices, which continue to come under pressure. The average stock that has reported has opened higher, says Bespoke, only for things to then turn "ugly" and for prices to end the day lower. Why? Well, the revenue beat rate – 64 per cent – hasn't been as impressive, although it's hardly cause for concern either. More likely, says the ordinarily bullish Prof Jeremy Siegel, excellent earnings were already priced into stocks after the big rally late last year. Expecting higher stock prices because of strong earnings is "double counting", given those gains. Then there are the myriad of macroeconomic concerns currently preoccupying investors. "Traders have used every chance they can get to sell shares after they've experienced their initial gap at the open," says Bespoke. "From a macro perspective, we view this type of action as a bearish signal."
Tencent falls into bear market
Plunging values in many US technology giants have dominated recent market coverage, but they're not the only ones to be suffering. Chinese internet giant Tencent last week fell into its first bear market – a fall of at least 20 per cent – since 2015. Though a relative unknown in the West, Tencent is one of the most valuable companies in the world and was the first Asian company to command a market capitalisation of over $500 billion. The prospect of a regulatory clampdown on technology companies in the US and Europe shouldn't necessarily impact Tencent, which earns the vast majority of its revenue in China. Like other tech stocks, however, Tencent had enjoyed huge gains – it more than doubled last year and is up over 600 per cent over the past five years. The recent falls, like those of other Chinese tech giants like Alibaba and Baidu, highlights the globalised nature of today's markets and how the tech selloff also reflects a wariness of stocks that have risen too far, too fast.
Should investors be spooked by Caterpillar warning?
Markets were rocked last week by manufacturing giant Caterpillar's warning that its first-quarter earnings might be a "high watermark" for 2018. Caterpillar is regarded as a bellwether for the industrial sector and the market as a whole. Its stock performance has closely tracked indices in recent years. Consequently, the "high watermark" comment triggered fears the global business cycle has peaked. The concern may be overdone, however. Firstly, Caterpillar said it's not worried about a cycle peak. Secondly, Caterpillar's outlook may reflect company-specific concerns; it expects costs to rise significantly in the remainder of 2018, but this may merely reflect that the company's spending was slow in the first quarter. Importantly, S&P 500 profits are forecast to enjoy double-digit gains for the next two years at least, while the ratio of positive versus negative language used by executives on earnings calls has been strong, according to Merrill Lynch strategist Savita Subramanian. Managements' optimistic tone indicates "no cracks yet in corporate America's rosy outlook", says Subramanian, suggesting investors may have read too much into Caterpillar's comments.
