Bond yields crush risky assets

October is shaping up as another volatile month as soaring bond yields crush risky assets but some are betting on rebound.

A single Australian One Dollar coin standing on its edge on top of Australian fifty dollar bills; saving money generic

October is shaping up as another volatile month for investors as soaring bond yields crush risky assets, although some analysts are counting on a rebound.

As sharemarkets probe key chart support levels and central bank officials flag the potential for more rate hikes, there is potential for sharp falls in coming days.

The S&P/ASX 200 share index is down 2.2 per cent for the month so far, hitting an 11-month low of 6871 points on Wednesday after a bruising 3.5 per cent fall in September. The Aussie dollar is off 2 per cent, with an 11-month low of US62.86c.

Meanwhile Australia’s 10-year bond yield is up from 4.51 to 4.68 per cent – a 12-year high – after a 25 basis points lift in the US 10-year yield, to a 16-year high of 4.86 per cent.

The falls come as the global benchmark US 10-year Treasury bond yield continues to surge amid a brutal sell-off in the bond market globally, as US economic data have been surprisingly resilient and Fed officials lessening their rate cut projections for 2024 and 2025.

The “risk free” rate used to price assets around the world has soared about 100 basis points since late July when the US economy improved and the government revealed a budget deficit blowout.

“While it’s expected that yields will ease to 4.25 per cent by year-end and further down to 3.75 per cent in late 2024, this will likely require a weaker economy, a looser labour market, and lower inflation to convince investors to catch a falling knife,” said SPI Asset Management’s Stephen Innes.

After rising almost 8 per cent in the first few weeks of calendar 2023, the local sharemarket has fallen about 9 per cent, slightly exceeding a February-March drop during the US regional banking crisis, which quickly led the Fed to provide emergency funding to support the banking sector.

With the Aussie dollar down almost 8 per cent this year, offshore investors have fared much worse.

China’s faltering economic rebound has been a factor, although China is on holidays this week.

But some analysts are betting that shares will bottom this month after a weak September.

October tends to be a positive month and usually the start of a more positive period for stocks that often continues to April, according to Macquarie Equities.

“Over the last 10 years, stock returns tend to be more positive in October when the preceding September was negative,” said Macquarie’s Australian equity strategist, Matthew Brooks.

And while it remains to be seen whether US companies will live up to earnings expectations after a sudden rise in interest rates, at least a US recession is no longer on the short-term horizon, he said.

“We were concerned about the negative impact of global rate hikes and expected a US recession,” Mr Brooks said. “However, the widely expected recession has been kicked down the road multiple times and this could happen again.”

Based on the OECD leading indicator, the global business cycle entered an “expansion-like phase” in June, after a “soft landing” in October 2022.

A key shift in Macquarie’s view is that, in hindsight, markets had a soft landing in October 2022.

“Returns across equities, credit, currencies, commodities and volatility are all fairly consistent with the trough in the OECD leading indicator in October 2022,” Mr Brooks said.

While he had previously expected headwinds from global hikes to cause the post-October 2022 recovery in the OECD indicator to stall, as it did ahead of the 1990s recession, he now says an expansion phase started in June.

US recession don’t start when the market cycle is in such an expansion phase – 90 per cent of US recessions since 1957 started in a downturn phase in the economic data, according to Mr Brooks.

“Ex- a shock like Covid-19, we are unlikely to progress to the downturn phase for at least eight months,” he said.

In his view the current “bear steepening” of the US bond yield curve doesn’t signal an imminent US recession either, as the average time from peak inversion to the start of a recession was 12-16 months. With peak inversion seen in June, that would suggest a recession starting in June-October 2024.

Moreover, one market shift that often happens in expansion phases is a rise in the US 10-year bond yield. After a 100 basis point rise since June, he says the rise in yields is “mostly done.”

“Falling long bond yields would provide support for equities and add to the positive seasonality for equities over the balance of 2023,” Mr Brooks said.

But while reducing the “defensiveness” of his model portfolio as recession isn’t imminent, he warns against highly cyclical stocks, especially those with weak balance sheets or low liquidity.

Similarly, Bell Potter head of institutional sales and trading, Richard Coppleson, said the sharp fall in shares in the past two months is “setting up opportunities in the market.”

“In the past whenever you see just so many stocks hitting new lows it indicates the market is oversold and a big bounce is coming,” he said.

“The only time it doesn’t is when we are in absolute turmoil.”

“Given the US and Australia are near the end of the rate cycle – rather than at the start – a low will come as soon as the market takes its intense interest off US 10-year bonds. The October volatility indicates that a bottom in this sell-off could be just a few weeks away.”