The quick move higher in bond yields is sending a warning about the stock market — especially growth stocks.

The benchmark 10-year Treasury has risen about 20 basis points since the start of the year — 1 basis point equals 0.01% — and was at 1.13% Monday. Still relatively low, the yield is at the highest it’s been since last March, but in itself the yield is not a problem.

The move could be signaling a period of more volatility for the stock market and the potential for more pressure on FANG and the other growth names that helped take the stock market higher last year. Some strategists expect those Big Tech and growth stocks to slow their gains this year, as value and cyclical names move higher on prospects that vaccinations will lead to an improving economy.

Strategists do not see yields at current levels halting the stock market’s gains, but the expectation that rates will continue to rise could make the ride bumpier for stock investors.

“I think the path of least resistance … is still up. … The technicals supporting this market are strong, but if you’re looking for warning signs there are some warning signs coming out of the fixed-income market,” said Mohamed El-Erian, chief economic adviser at Allianz.

El-Erian, in a CNBC interview, said yields have been rising on longer-duration bonds, such as the 10-year and 30-year bond, but the 2-year yield has stayed low, anchored by the Fed’s zero interest rate policy. The 10-year is widely watched, since it influences mortgages and other lending rates.

“It’s going up for the wrong reason, not because of growth but because of a combination of buyers getting hesitant and people worried about inflation, not reflation,” El-Erian said. “So if that continues, if you get another 20 basis points in another five or six trading sessions, then it’s flashing yellow a lot brighter at that point.”

The 10-year yield edged above the psychological 1% level last week after Democrats won two Georgia Senate seats, giving the Democrats control of the Senate. That prompted more selling in bonds, as investors speculated President-elect Joe Biden will now be able to push through his plans for trillions in spending. More stimulus means more debt and more Treasury issuance to pay for it, a recipe for higher yields. Yields move opposite to price.

“In the last few weeks, we made the leap to rising rates being neutral, to rising rates being positive, to today where you can argue that rates moving higher from here is likely to be a headwind for stocks, particularly high growth, high P/E stocks,” said Julian Emanuel, head of equities and derivatives strategy at BTIG. Emanuel notes investors have already begun the shift away from high growth to value over the last several months.

Emanuel expects the S&P 500 to reach 4,000 by year-end, but he also sees the market as entering a new phase of speculation, with both upside and downside volatility.

He said evidence of the speculative phase is apparent in the way the stock market continued its advance as the 10-year moved rapidly above 1%. He also pointed to the fact that stocks were not rattled much last week when a violent mob seized control of the U.S. Capitol during a session of Congress. Stocks also continued to climb as Covid cases mounted and deaths hit a new record daily level. The market also ignored a very weak employment report Friday.

“We’re in the more speculative phase of the rally. The price action confirms we’re in the more speculative phase of the rally. It doesn’t mean you’re imminently going to make a top, but you should be ready for more volatility. We’re comfortable with 4,000, but it’s possible you could see a series of 10%-plus corrections along the way of getting there,” Emanuel said.

Strategists say it’s even more important for corporate earnings to be strong in an environment of rising yields. Strategists at both Goldman Sachs and Morgan Stanley on Monday warned that higher interest rates could put a lid on market gains.

“Higher rates is the wild card and could begin a period of falling equity valuations, making earnings revisions even more important than usual for stock performance,” wrote Morgan Stanley strategists.

Goldman strategists said more fiscal stimulus should lead to higher 2021 earnings, but rising rates could cap the upside for stock multiples. The multiple is the price-to-earnings ratio, and many growth stocks are at very high levels. Amazon, for instance, has a P/E of 91. Amazon was down 1.8% Monday, while other members of FANG — Alphabet, Facebook and Netflix — were also lower.

“You’re going to get more volatility to the upside and downside,” said Emanuel. “You may get a marginal new high here, in the next several days, but by and large what you’re going to see is the market get more selective, the higher up you go, and that increases the odds that you get a much fuller, more comprehensive correction, led by high multiple growth stocks.”

Dan Suzuki, deputy CIO at Richard Bernstein Advisors, said the type of stocks that should do better are cyclicals or value names, the same types of stocks that are more insulated from rising rates.

“Basically, by definition, a high P/E stock is also embedding a lot of growth. If you are to put it in valuation terms, a lot of the value of the stock is far into the future. That value that’s far in the future is more sensitive to interest rates. The more those rates go up, the more you discount future value,” he said.

SOURCE : https://www.cnbc.com/2021/01/11/what-rising-rates-could-mean-for-the-stock-market.html