Market Volatility: The Hidden Culprit
The stock market’s recent turmoil can be attributed to a single, underlying factor: rising interest rates. The 10-year Treasury yield has surged nearly 50 basis points in the past month, reaching above 4.6% for the first time since May 2023. This sudden spike has sent the S&P 500 tumbling, down more than 1% over the same period.
The Rate Conundrum
Morgan Stanley’s chief investment officer, Mike Wilson, believes that the root cause of the market’s choppiness lies in the rising rates. He notes that the correlation between equity returns and bond yields has flipped into negative territory, a phenomenon not seen since last summer. This means that as yields rise, stocks fall, and vice versa.
Economic Data: A Double-Edged Sword
Better-than-expected economic data isn’t the driving force behind the rising yields. Instead, it’s the rates themselves that are weighing on equities. This creates a delicate balance, where stronger economic data could lead to higher rates, ultimately hurting the stock market.
The Impact on Small Caps and Big Tech
Higher rates disproportionately affect small caps, which may struggle to refinance at higher borrowing rates. This has led to a large-cap bias in the market, with Big Tech dominating the landscape. Wilson advises investors to focus on companies with stronger balance sheets and less leverage, as they are less rate-sensitive.
The Dollar’s Rise: Another Headwind
The US dollar has reached a two-year high, putting pressure on equities with significant foreign sales exposure. This could impact companies that have driven recent earnings growth for the S&P 500.
Finding the Antidote
So, what’s the solution to this higher rate quandary? Piper Sandler’s chief investment strategist, Michael Kantrowitz, suggests that weaker-than-expected economic data could be the catalyst to bring rates lower. However, the question remains: how much softer economic data would be welcome?
The Fine Line
The economy must walk a fine line between being weak enough to warrant lower rates and strong enough to avoid significant slowing. The labor market has already cooled, and further softening could be a double-edged sword. Fed Chair Jerome Powell has made it clear that his team doesn’t welcome further labor market softening.
The December Jobs Report: A Key Indicator
This Friday’s release of the December jobs report will provide insight into whether the market is truly waiting for bad economic news to heal its higher rate woes. One thing is certain: the market’s fate is closely tied to the trajectory of interest rates.
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