The financial markets freaked out last week as yields rose on fears, yet again (sigh), of growing inflationary pressure. The benchmark 10-yr Treasury yield briefly crossed 1.6% Thursday, the highest level in a year, sparking a sell-off in Growth and Momentum stocks. But so what? The 10-yr was back at only pre-Covid levels, and everyone knew those stocks were grossly overvalued...Yes, the 12-month CPI came in at 1.4% in Jan vs the average of 1.2% for 2020. And true, there is another $1.9T of stimulus on the way even as the economy is poised to take-off (Goldman Sachs is forecasting ~7% GDP growth for 2021). From that angle, you might expect some handwringing in the media about inflation... though sell-side research loves to cheerlead remind clients rising yields is good for stocks as it reflects strong fundamentals (there's never a bad reason not to own stocks).
But, what seemed to really have panicked the markets was the disorderly nature of the bond sell-off. The magnitude of the move last week was more than 2 standard deviations, which is typically associated falling equity prices. So last week both bonds and stocks lost value together. The nightmare scenario from a portfolio construction perspective! Anyways...continuing with what happened...Goldman Sachs' Portfolio Strategy team notes that long-duration growth stocks fared especially poorly, including a 15% sell-off in a basket of non-profitable tech stocks that had risen by 230% since the start of 2020. In contrast, cyclicals with falling sales in 2020 have returned +25% YTD. There was also the chart below, which got a lot of attention showing the 10-yr was now yielding as much as stocks and signaling potentially more outflows out of stocks as investors re-think their income source:
But we've been here before...as the above chart shows, including famously in 2013 with the "Taper Tantrum." Each time growth has been slower than expected and inflation way lower than anticipated. I'm with PIMCO's Dan Ivascyn, who continues to see "powerful disinflationary trends. [And] after an initial recovery there is likely a world of excess capacity." In Ivascyn's opinion, inflation will remain contained due to secular trends in demographics, technology and weakness of organized labor. The upshot is a material risk of an "inflation head fake."
