Tuesday, 1 May 2018

Stock Market: Effect of Rising Bond Yield on Growth Stocks

Lately, i'm preoccupied by the effect of rising bond yield (using 10 Year T Notes as a bench mark) on the equity market. Especially on growth stocks. And by growth stocks, what are more obvious than stocks in QQQ. The mega tech caps and the likes?

Soon after Trump took office, those mega tech caps like FANG or FAAMG (FB, AAPL, AMZN, NFLX, and GOOG) under-performed the broad market (SPY). I thought it was Trump's hostile attitude towards the CEOs of Silicon Valley (with a laser focused cross-hairs reserved for Jeff Bezos). Most of them are Clinton's supporters. This is their 1st meeting with the POTUS in the Trump Tower. This photo shows that, except for one CEO, the rest of them don't look like a bunch of happy campers.

Don't they look tense?

But with the latest under-performance of these stocks, it finally dawned on me that in both instances, it was due to the rising yields (not Trump. Not in this instance). Rising yield has bigger impact on growth stocks than value stocks. And FANG or QQQ stocks would be qualified as growth stocks.

To back up my thesis, i place the 3 charts side by side for comparison. QQQ/SPY Ratio chart is included to show the relative performance of QQQ to the general market. And VUG/VTV ratio chart is to compare Growth vs Value stocks using these 2 relevant ETFs. To my surprise, the bottom two ratio charts are practically identical. You can think of QQQ as mostly growth stocks while SPY are dominated by value stocks.

(Click to enlarge)

If you look at the TNX yield verses QQQ/SPY ratio, from arrows 1 to 3 they move in the opposite directions as expected. Higher yields is bad for growth stocks of QQQ. Except for arrow 4 where i could only explain as the momentum overshoot or FANG entered its mania phase (and nothing could derail them). The QQQ/SPY ratio in arrow 4 period is exhibiting the characteristics of a blow-off top as prices break above the QQQ/SPY purple channel.

As for arrow 5, i expect the relationship between TNX and QQQ/SPY curve would break down because this is the period in the midst of correction. I think the comparison works best when they're in a "steady state". In other words, not in an extreme volatile period of correction where market's main theme or narratives aren't observed.

What's also interesting is that when i look further back a few years preceding Trump's presidency, there's little correlation between yield and growth stocks. This isn't surprising because before the Election Day, TNX yield was only 1.7%. TNX spiked to above 2.6% in a month or so. When TNX is much closer to 3%, yield becomes matter.

It isn't just mega caps, i would also put semiconductor companies as growth stocks. This also explains their bearishness of late. The price drops aren't reflecting anything operational, but simply a revaluation or rotation from growth to value stocks in the environment of rising yields.

Anyway, as i was researching for post on the internet, i found a chart that shows a long term view of the correlation between yield and growth stocks.

Effect of Rising interest rates on Growth and Value stocks

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