We’re trying to not get dragged into too many stories comparing the current stock market environment to the tech boom of the late 1990s and 200, but they keep pullin’ us back in.
This time it’s because technology stocks and bond yields, which usually, happily, chug along mostly in unison, are now seeing the largest divergence in years.
Why? And what does that mean?
Here’s commentary from Lisa Shalet, Chief Investment Officer of Morgan Stanley Wealth Management.
“For most of the last 20 years, tech stocks have traded directionally with economic growth—carrying a positive correlation with long-duration Treasury yields—as investors viewed them as tied to positive economic growth.
Now, Shalet observes, “bountiful liquidity” is distorting interest rates and tech stocks, which are now negatively correlated at the lowest level since 2000.
“With tech trading at a 60% premium to an already expensive market, interest rate sensitivity is once again negative, suggesting any backup in yields will be a powerful headwind.
This index concentration in tech stocks increases market fragility.”
“The second quarter closed with growth-dominated U.S. stock indexes at all-time highs and up more than 14% for the year to date, while value and cyclical stocks lagged despite forecasts for near 10% nominal GDP growth this year.
This dynamic may be explained by the 30-basis-point pullback in the 10-year US Treasury yield and a hawkish tilt by the Federal Reserve.”
“The fall in 10-year Treasury rates simply bolsters long-duration assets. But is nearly everything now a long-duration asset?”
Stocks classified as “bond proxies” have increased to more than 35% of the index’s market capitalization from the usual 20-25%:
“And those stocks are disproportionately found among the megacap tech category killers.
That megacap tech stocks have been behaving like bond proxies not only undermines portfolio diversification efforts but increases the stock market’s vulnerability to a pickup in rates.
Tech stocks are only priced to yield about 130 basis points more than the 10-year Treasury.”
“In a market awash with liquidity, a zero lower bound on the fed funds rate, extreme stock valuations, bond indexes at above-average duration and corporate credit spreads at historic tights, interest rate sensitivity has rarely been greater.”