By Lewis Krauskopf
NEW YORK (Reuters) – Spooked one week, sanguine the next.
Some stock investors are drawing optimism from the market’s ability to move upwards in the face of loftier yields – even though those higher yields were partly blamed for last week’s violent selloff.
Those investors are optimistic about economic growth, and stocks that can benefit from that environment, although they concede the overhanging risk that a sharp spike in yields could cause another rout.
“Even though yields are moving higher, the equity market seems to be continuing to follow through on some of the upward movement that we saw earlier in the year that is related to global growth,” said Tracie McMillion, head of global asset allocation strategy at Wells Fargo Investment Institute in Winston-Salem, North Carolina.
Rising yields spooked the stock market last week, following employment data on Friday that caused concerns about inflationary pressures.
However, this week has seen a rising stock market, despite yields remaining near their four-year-high.
Wednesday’s move up in stocks – including a 1.3 percent surge for the S&P 500 <.SPX> – came even as the benchmark 10-year Treasury’s yield rose from 2.84 percent to 2.91 percent, following closely watched inflation data showing U.S. consumer prices rose more than expected in January.
“The equity markets had to reprice for this (higher yield) environment, and now the stock market is saying: ‘We’re OK with this, Game On’,” said Jason Ware, Chief Investment Officer of Albion Financial in Utah, who said he still preferred stocks to bonds.
“It’s still a no brainer,” Ware said. “The total return for equities is so much more attractive than the meager income you get from bonds.”
Wednesday’s rise in stocks also came as volatility levels had fallen, with the Cboe Volatility index <.VIX> dropping into the 20s after rising as high as 50 a week earlier, and coincided with expiring VIX futures and options.
Rising bond yields threaten stocks because they present investment competition following years of very low rates that supported equities. Increasing rates also could indicate a tightening of economic conditions.
“I think the turnaround in the equity market was more associated with an improving economy and removing the focus on the yield environment,” said Robert Pavlik, chief investment strategist, senior portfolio manager at SlateStone Wealth LLC in New York.
“The market switched its attention to, ‘OK, we have an expanding economy, it’s not running so hot that I have to be overly worried about interest rates.’”
Pavlik and McMillion favor sectors that should perform well during an improving economy, including financials and consumer discretionary stocks.
Since October, the S&P 500 and 10-year Treasury yields have been positively correlated, moving in the same direction, when viewed over a mid-term, 60-day period, according to Thomson Reuters data.
But the move higher came as bond yields were rising off of very low levels. The benchmark 10-year yield hovered on Thursday around 2.90 percent after touching a more-than four year high during the session.
“If the economy is accelerating then we should be able to handle higher bond yields and not derail the economy,” said Willie Delwiche, investment strategist at Baird in Milwaukee. “If growth is accelerating and moving higher, then along the way we can handle higher levels.”
The biggest risk from rates is a fast move higher in yields that catches the market off guard, as opposed to breaching a specific level, Delwiche said.
But if the benchmark 10-year tops 3 percent, that could cause some fear for stock investors, said Brian Shepardson, portfolio manager for the James Balanced Golden Rainbow fund, in Alpha, Ohio.
“If higher rates are what caused the market to pull back, that is still a concern,” Shepardson said. “Nothing has changed fundamentally within the market.”
(Reporting by Lewis Krauskopf; additional reporting by Megan Davies; Editing by Phil Berlowitz)