February 22, 2021: Rising Bond Yields And Current Stock Trends

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As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Rising Bond Yields And Current Stock Trends

There’s been an undercurrent that has worried stock investors: rising bond yields (or interest rates). In this newsletter, we review current bond segment trends and look at how much the rising rates have affected stock trends.

Bond interest rates are rising but not everywhere

It’s been striking to see that 10 year Treasury note’s rate has risen so much this year — from 0.916% to the current 1.369%:

Investors pay special attention to long term interest rates as they are not directly controlled by the Federal Reserve but they directly affect the costs of real estates (mortgage rates) and borrowing costs for most capital expenditure for businesses.

Let’s take a look at the various bond segment return trends (remember rising bond yields or interest rates means lower bond prices):

Bond segment trend scores (see 360° Market Overview for more details):

as of 2/19/2021:

Description	Symbol	4 Weeks	13 Weeks	Trend Score
International Inflation Protected	WIP	-0.44%	3.4%	3.07%
High Yield	JNK	0.7%	3.26%	2.98%
High Yield Muni	VWAHX	0.49%	2.52%	1.98%
Long Term Muni	VWLUX	0.14%	1.32%	1.38%
Interm Term Muni	VWIUX	0.05%	0.91%	1.08%
Floating Rate	FLOT	0.1%	0.33%	0.34%
Inflation Protected	TIP	-1.46%	0.2%	0.95%
Short Term Treasury	SHY	0.02%	0.11%	0.53%
Short Term Credit	IGSB	-0.16%	0.04%	0.53%
Treasury Bills	SHV	0.01%	0.0%	0.11%
MBS Bond	MBB	-0.23%	-0.04%	0.45%
International Treasury	BWX	-1.77%	-0.3%	1.39%
Emerging Mkt Bonds	PCY	-1.59%	-0.43%	-1.28%
Intermediate Term Credit	IGIB	-0.99%	-1.11%	-0.02%
US Total Bond	BND	-1.12%	-1.76%	-0.46%
Long Term Credit	LQD	-1.67%	-2.62%	-0.55%
Intermediate Treasury	IEF	-1.66%	-3.1%	-1.39%
10-20Year Treasury	TLH	-4.27%	-8.73%	-5.33%
20+ Year Treasury	TLT	-5.56%	-11.01%	-6.85%

Observations:

Total bond, intermediate and long term Treasury, intermediate and long term credit (investment grade) corporate bonds and emerging mkt bonds are all in a downtrend (defined by negative trend scores). All of these bonds have lost money for the past 3 months (13 weeks).
However, inflation protected bonds have had some good returns for the past 13 weeks or so, indicating investors’ concerns about inflation.
High yield corporate bonds and muni bonds are doing well, showing the continuing appetite for risk assets
Interestingly, muni bonds are strong: the likely reason is that investors believe local and state governments will receive strong financial support from the federal government in this pandemic crisis period.

The current bond market situation is a typical scenario where interest rate risk is rising while the other major bond market risk — credit risk somewhat remains muted. As usual, markets are guessing future direction by trial and error: investors are concerned about likely inflation but are hopeful on strong economic recovery from the current pandemic.

Stock internals and trends

One of the worrisome effects for rising bond yields is that it might derail stocks’ uptrends because rising interest rates eventually raise borrowing cost for businesses. However, in a period when economy grows fast, interest rates can also rise without much affecting stock prices. In essence, if rising borrowing cost can be easily offset by business profits, rising rates are actually welcome as they can slow down inflation.

Let’s take a look at some stock internals. First, we take a note that value and small stocks have been rising while large and growth stocks are stagnant:

Small cap stocks (IWM) have outperformed large stocks (SPY) by big margins year to date.
Value stocks (IWD — Russell 1000 large value stock ETF) has done better than growth stocks (IWF — Russell 1000 large growth stock ETF).

Looking at the trends, we see a small aberration last week for stocks, but their up trends are still largely intact:

US Equity Style Trend (as of 02/19/2021):

Description	Symbol	1 Week	13 Weeks	Trend Score
Russell Smallcap Growth	IWO	-2.03%	27.88%	24.55%
Russell Smallcap Index	IWM	-0.91%	27.26%	22.89%
Russell Smallcap Value	IWN	0.15%	26.43%	20.81%
Russell Midcap Growth	IWP	-1.33%	16.56%	17.26%
Russell Midcap Indedx	IWR	-0.12%	15.4%	14.41%
Russell Midcap Value	IWS	0.54%	14.74%	12.29%
Russell Largecap Value	IWD	0.23%	11.88%	9.18%
Russell Largecap Index	IWB	-0.69%	11.66%	10.78%
Russell Largecap Growth	IWF	-1.68%	11.24%	11.99%

Observations:

The large to small sector rotation has been underway for a while now, as evident by their trend scores that are sensitive to intermediate time frames.
However, it does look like growth to value transition is also happening: last week, all value stocks had positive returns while growth stocks and blended stocks lost money.

The other way to gauge stock internals is to look at the following rate sensitive sectors:

In general, REIT sector (VNQ) is sensitive to interest rates but so far this year, it has been strong (granted, investors might be more encouraged by the upcoming recovery in real estates than being worried about the rising rate effect). On the other hand, utility sector (XLU) has been affected as expected (rising rates will usually affect utility businesses because of the borrowing cost before these companies can raise their prices). Financial sector, represented by XLF, has risen too as investors expect banks and other financial companies can reap more lending profits while still maintaining low cost of money (mostly decided by short term rates that haven’t moved much). In a word, investors’ reaction has been all over the map and doesn’t offer a strong direction.

Based on the above data, we don’t see much trend change for stocks at the moment. However, it’s clear that internally, sector rotation has been underway. This is especially noticeable between large and small, growth and value.

Market overview

Q4 earnings reports are wrapping up, 83% of the S&P 500 companies have reported results and now the blended earnings growth is 3.2%, continue to outperform the expectation: the blended Q4 earnings growth was 1.7% three weeks ago, and before that, -2.3%, further before, -4.7%, and -9.2% expected on 12/31/2020.

Even though our observations in the above have not caused a big alarm on the fast rising interest rates, we are reminded that the current stock valuation is at some historical extreme high levels while stock prices are rising relentless without much stop. Furthermore, we are seeing many anecdotes in stock markets that are typically seen in a super speculative environment. Among them are the GameStop stock trading frenzy and the vertical bitcoin price ascent which up to now, we are still having a hard time to wrap our head around, In such a highly unstable environment, things can change fast and investors should be well prepared for them.

Again, in the current very over-valued and over-extended markets, we reiterate the following practice:

For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or longer. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation now reached another high. For the moment, we believe it’s prudent to be cautious while riding on market uptrend. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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