Sharemarkets get the wobbles as bond yields lift

Rising bond yields are again starting to challenge stock ­valuations and the US sharemarket missed its record as the US 10-year bond yield jumped to a four-month high.

Traders assess conditions from the floor of the New York Stock Exchange. Picture: AFP

Rising bond yields are again starting to challenge sharemarket ­valuations.

In a case of “good news is bad news”, the US sharemarket shied off record highs as the US 10-year bond yield jumped to a four-month high of 4.4 per cent after the important ISM manufacturing survey showed growth for the first time since 2022 and new ­orders and prices jumped.

The US 10-year bond yield has risen 16 basis points in two days – its fastest rise in two months – reinforcing an uptrend in which the “risk-free” rate has risen from a late 2023 low of 3.78 per cent.

The US money market was expecting more than six US interest rate cuts this year. But after stronger than expected inflation and economic data in recent months, market pricing now implies less than the three interest rate cuts of 25 basis points projected by FOMC officials.

The Australian market has also suffered a case of the wobbles after hitting a record high on Tuesday.

Despite ongoing strength in commodities – including crude oil, gold and copper – and a rebound in iron ore prices after China’s official manufacturing and services sector PMI data rose more than expected, the ASX 200 index fell as much as 1.5 per cent on Wednesday.

Sharp falls in market darlings including WiseTech, Xero, NextDC, Pro Medicus, James Hardie, Goodman and Commonwealth Bank suggested the rise in bond yields caused profit-taking.

Capital Economics economist James Reilly noted that US stocks had “largely shrugged off” rising bond yields over the past year and that they should be more of a headwind for “growth” stocks rather than “value” stocks, even though Big Tech has been bolstered by the AI theme.

Any impact of high Treasury yields on stocks depended on why they remained high.

“If Treasury yields remained high or rose because of continued US economic resilience, we think that would probably be a backdrop in which enthusiasm around AI builds and, like for large parts of 2023, the stockmarket ignores rising yields,” he said.

“If, however, yields remain high even as economic activity sours, due to another shock to supply chains for example, then bonds and equities could sell off in tandem.

“But such a scenario seems unlikely to us – our base case is that both assets rally this year, and that US ‘growth’ stocks continue to fare well.”

However, JPMorgan warned that the gap between the level of the US sharemarket and the market’s projections for the amount of US interest rate cuts that are likely this year has widened.

The bank says US bond yields are fundamentally set to move lower in the second half of 2024.

But there’s been a notable rise in market pricing of inflation risk as inflation could prove to be “sticky”. At the same time, term premiums for US bonds are “outright negative again”, suggesting a “lot of complacency in the bond market with respect to the inflation risk”.

“Consequently, the gap that has opened up this year between Fed futures and the equity market is getting wider,” said JPMorgan’s head of global equity strategy, ­Mislav Matejka.

“Equities rallied almost 30 per cent from last October lows, driven in November-December by the expectation of a Fed pivot, and the belief that Fed could be cutting already in March. These projections have fully reversed.”

At the stockmarket lows in October, the Fed was expected to cut rates by 80 basis points this year.

At the point of peak dovishness in January, as much as 180 basis points of cuts were expected.

Now these US rate cut projections have shrunk all the way back to 69 basis points.

“Equities are ignoring the most recent pivot of a pivot, which might be a mistake,” Mr Matejka said.

While the market is probably assuming a growth acceleration comes to the rescue in the second half, earnings projections for 2024 still aren’t moving up.

At the same time, the market is “too complacent with respect to downside risks”, with recession odds “likely too low”. Cyclicals are at their most expensive point versus defensives since 2009-2010, which was a time when a synchronised global recovery was under way after the GFC.

Mr Matejka said that was unlikely to be the template this time around, and it could act as a headwind.

The next time bond yields fall as significantly as they did in ­November-December when the 10-year yield fell from 4.92 per cent to 3.79 per cent, he said he didn’t think the stockmarket would react positively.

Instead, it might revert to a more traditional negative correlation between bond yields and equities.

Overall Mr Matejka warned that the US economy was slowing – the labour markets were a bright spot, for now, but that could change quickly, and retail sales momentum was waning.

US jobs data is due on Friday.

The upward repricing of Fed futures in recent weeks might not be due only to a better growth outlook, but also to more persistent inflation, highlighted by FOMC member Christopher Waller last week when he said “there is no rush to cut the policy rate”.

Recent data made it “prudent to hold this rate at its current restrictive stance perhaps for longer than previously thought to help keep inflation on a sustainable trajectory towards 2 per cent”.

JPMorgan’s Mr Matejka also noted that the US Treasury yield curve remained “strongly inverted”, as it had been since October 2022, and that was “historically an ominous sign”.

At the same time US corporate profit margins are softening, their revenue growth is weakening, and net interest expenses are set to move back up. Earnings per share forecasts for the S&P 500, calling for 10 per cent profit growth this year, are “at risk of downgrades”, according to JPMorgan.

“At 21 times, the S&P 500’s forward PE ratio is very stretched, especially versus real bond yields,” Mr Matejka added.