The equity markets experienced a significant decline to end trading in the red on February 25, 2021. While the Dow Jones Industrial Average was down 1.8%, the S&P 500 slumped 2.5% and the tech-heavy NASDAQ lost 3.5%.
One of the main reasons for the decline in stock markets was the riding yields of 10-year bonds that were trading at its highest value in the last 12-months. Interest rates and equity markets have an inverse relationship as higher interest rates present an attractive investment opportunity for income and risk-averse investors.
According to a report from MarketWatch, “A rise in bond yields, with the 10-year Treasury note TMUBMUSD10Y, 1.519% advancing to above a psychological threshold at around 1.5%, has put pressure on stocks and gold, forcing investors to reassess the relative value of owning either asset against the backdrop of richer rates from risk-free Treasuries.”
10-Year Treasury yield touched a high of 1.614%
The 10-year Treasury yield rose to 1.614% in intra-day trading which was the highest since February 14, 2020. Investors believe that the rise in interest rates might be due to inflation instead of economic recovery.
In January the 10-year yield was below 1%. This suggests it has gained more than half a percentage point in less than two months which is “quite rapid for the bond market and relative to rates at these historically low levels.”
According to Societe Generale strategist Albert Edwards, “To be sure, if bond yields continue to rise and there is a smooth rotation out of growth and defensive stocks into value and cyclical stocks, the Fed will remain sanguine.”
He added, “But the risk is growing that with so many bubbles blown by the Fed something will burst soon.”
According to a CNBC report, consumer prices were up 1.4% year over year in January and macro indicators of retail sales as well as durable goods purchases have shown that inflation will disrupt the markets in 2021.
In fact, the 5-year breakeven rate which is an indicator of the bond market’s estimates for inflation touched 2.4% earlier this week. It was the highest level since the financial crisis of 2008.
Fed Reserve chairman Jerome Powell expects a surge in consumer spending as the economy is reopened. However, this will not be a long-term trend and high prices might not be sustainable.
What next for investors?
While high bond rates have spooked investors, the weekly data for unemployment insurance claims stood at 730,000 well below the expected figure of 845,000 as forecast by economists. The GDP growth estimate for Q4 stands at 4.1% which was also above estimates.
Its quite evident that there is a strong disconnect between the economy and equity markets all around the world. Investors and analysts are not able to decode the stellar gains posted by the S&P 500 since it entered bear market territory last year.
There is good chance that the stocks markets will crash once again due to steep valuations, rising interest rates and the end of stimulus programs.
Related: Should Advisors Expect a Market Crash in 2021?
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