Bond yields hold the key to an emotional market that can change on a dime, says this strategist

Early electronic skirmishing Friday points to the S&P 500
opening near a seven-week trough. Wall Street’s equity benchmark is down 10 of the last 13 sessions with a number of suspects getting the blame.

Worries about China’s economy, seasonal softness, higher energy prices and surging bond yields have all apparently provided an excuse for profit taking, particularly in some of the more richly-valued heavyweight tech stocks.

This is just the latest vacillation that Michael Kantrowitz, chief investment strategist at Piper Sandler, says is part of the market’s trend of swinging up and down since early 2022 mostly on changes in market multiples, or price to earnings ratios, as opposed to fundamental cyclical concerns.

“In the most simplistic sense, P/Es are just…[a] figure that represent emotional views of investors. While many variables factor into valuation, over the short run, it’s investors’ perception of risks that dominate,” says Kantrowitz in a note to clients published late Thursday.

Price-to-earnings ratios have vacillated, far more than earnings expectations.

Source: Piper Sandler

And he is of the view that right now it is the moves in bond yields that are driving that emotion.

Taking October 2022 as a guide, he notes that stocks began to rally when views and data on inflation began to cool down, overcoming any concerns about macroeconomic weakness and falling earnings. Investors believed the Fed was done raising rates and that the economy would have a soft landing: thus good news drove stocks higher.

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“Recall, the market got off to a great start this year largely due to views that bonds yields had peaked, especially after the March bank issues,” he says.

Today’s scenario is a bit different. The move to 15-year highs for 10-year bond yields is not solely because of inflation concerns, but a number of reasons including the relaxing of Japan’s yield curve control that has perhaps enticed some funds home. U.S. budget deficit worries may also be a factor, alongside positive economic surprises, and hawkish Fedspeak.

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Stocks have dropped as the 10-year yield has climbed.

Source: Piper Sandler

So what happens next?

Well, if bond yields can stabilize for what Kantrowitz calls good reasons, such as lower inflation, then we could see a rally in riskier assets. Should yields decline for bad reasons, like weaker macroeconomic data, especially relating to jobs, then risk-on assets may underperform and the supposedly haven large cap growth stocks may lead.

A further rise in yields would hurt small caps, value stocks, cyclical-sensitive assets and those with high betas, Kantrowitz warns.

However, he says that though higher rates pose a risk to stocks, they alone will not push the market down for a sustained period of time.

“At some point, equity weakness might be viewed as super bearish for the macro outlook and investors will return to the safety of bonds and policy makers will try to talk down yields … which could help to stabilize the situation,” says Kantrowitz.

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But for now, he stresses: “The thing about P/E-driven markets is that they can change on a dime – if the perception of risks changes, the markets do as well.”


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U.S. stock-index futures


are lower as benchmark Treasury yields
ease from recent multi-year highs. The dollar
is steady, while oil prices
are a touch firmer and gold

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The buzz

Traders may need to be on their toes as an estimated $2.2 trillion of stock options are due to expire on Friday.

Deere & Co.
is among those at the tail-end of the earnings season to release results before the opening bell. Shares in the farm equipment maker are a touch firmer after its 2023 guidance beat analyst estimates.

Shares of Farfetch Ltd. 
are slumping more than 35% in Friday’s premarket after the luxury fashion company reported sales below analysts forecasts.

Shares of Applied Materials Inc.
are up 3.5% after the chip industry equipment supplier reported earnings and forecast an outlook that topped Wall Street expectations.

China Evergrande, the heavily indebted group that is China’s second biggest developer, filed for bankruptcy late on Thursday.

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And in related news, China’s central bank on Friday stepped in to support the yuan amid concerns about the health of the world’s second biggest economy.

was trading below $27,000 after a sharp fall on Thursday following reports Elon Musk’s SpaceX had dumped its holding in the crypto currency.

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The chart

BCA Research has downgraded the semiconductor sector to underweight, and the charts below help explain why. Chip prices are falling pushing sales drastically lower, but share prices have done well.

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Source: BCA Research

“Demand for AI chips remains strong, but it does little good to most chip companies except Nvidia and AMD. TSMC said that AI chips account for only 6% of its sales,” says BCA. “The industry trades at 28.5x forward earnings, which is the 99th percentile relative to 10 years of history. The BCA Valuations and Technical indicators signal that the industry is both overvalued and overbought relative to the S&P 500. “

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

Ticker Security name
AMC Entertainment
T2 Biosystems
AMC Entertainment preferred
Mullen Automotive

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