Eq: Large Cap
Tech stocks had a big fall this week, but it more importantly it was the concentration of tech stocks that hedge funds loaded up on that took the biggest tumble. For instance, Farfetch Ltd. and Snowflake Inc. faced their largest drops since March. Hedge funds have been bullish on growth stocks and the high value/low income stocks set record holdings dating back to 2002. Driving tech’s downfall are rate hikes being priced into yields and undermining stocks hinging on future cash flows, like tech.
FINSUM: Tech stocks are more fragile than ever because profits are dwindling after the pandemic boost, and future rate hikes could cause serious tech blowback.
Treasury yields have been on the climb as of late. The 10 year Treasury is up as much as 30 basis points since mid September, and that climb has many dividend investors worried as to the value of the stocks they hold. Most income investors see rising yields challenging the value of income stocks, causing them to fall, but in the 15 times in the post war era that the 10-year has risen 1.5% from its low, the S&P grew by 12% annualized in this stretch. What this current Treasury climb has in common with its predecessors is inflation. The latest PCE posted a 30-year record, and that is being priced into Treasuries, which is eroding the traditional income stream. With realized gains in Treasuries lower than the nominal yields driving headlines, dividend investors might not need to be worried about stock valuations sinking.
FINSUM: If yields were being driven by growth factors, we might see the more traditional relationship between interest rates and asset prices, but an inflation-driven cycle might not push investors away from dividend equities.
The overall bond market is almost a bust this year but investors flocking for a yield can only go to one place, junk bonds. Lending conditions are very loose with all the accommodations both fiscal and monetary policy made this year, and those attempting to stream any income have to learn to high-yield debt. Inflation is eating up anything to be gained in treasuries. Investors are now treating high yield debt like a more liquid asset than ever purely because traditional bonds are losing to inflation. All of the policy measures have made many feel corporate debt is less risky than ever but the excess demand may be tipping, as even some of the riskiest debt is being sought after. Still high nominal economic growth is good for borrowers and reduces to investors.
FINSUM: Investors should be aware of interest rates pass-through from Fed tightening to corporate debt, strong inflation could lead to weaker pass through and even lower spreads than the market is already seeing.
Wall Street is about to start posting 3rd quarter earnings and market participants are expecting another big round of postings. Driving most of those earnings is robust growth in the overall economy, which drove the same blockbuster Q2 reports. Some of the highest expectations are in the banking sector as JPMorgan Chase & Co., Bank of America Corp., PNC Financial Services Group Inc., and U.S. Bancorp are looking to lead the pack. This is driven by micro factors in their companies but also macro factors that benefit financials as interest rates look to rise and the Fed begins tapering. Outside financials, large caps like UnitedHealth Group Inc. are also looking to post very high earnings with solid financials and its valuable brand Optum is driving earnings. The delta variant may have hamstrung some companies from the great Q2, but large-cap companies could be robust enough to withstand the covid resurgence.
FINSUM: Additionally, look to energy companies to post solid Q3 numbers as high prices helped bottom lines for these large-cap juggernauts.