The rise in US treasury yields is putting a scare to investors hoping for a continuation of the market’s incredible run, but don’t get too spooked, says Phil Orlando of Federated Hermes, who claims better than expected earnings are pointing to more room for equities to grow.
The ten year treasury yield has hit almost 1.38 per cent, making it the highest it’s been in a year on Monday, while the 30-year bond yield rose 2.3 basis points to 2.16 per cent. That growth has put pressure on bond prices and fuelled the flames of a market correction in response to the huge gains seen over the past ten or so months, to say nothing of the decade-long growth immediately behind us.
But investors shouldn’t be worried just yet, says Orlando, who points to strong fourth quarter results this earnings season.
“I think what the bond market is telling us is that the economy is recovering even more quickly than then they had expected and that nominal and core inflation is coming back more quickly than expected,” said Orlando, chief equity market strategist at Federated Hermes, speaking on BNN Bloomberg on Monday.
“If you’re losing money in bonds, theoretically that’s going to move some assets over to the equity side of the equation. So, with treasuries down here 1.3 per cent I think the TINA trade — ‘there is no alternative’ — is still very much in play,” he said.
“The [Federal Reserve] in our view isn’t going anywhere, so the funds rate is going to stay anchored at zero, so we think equities are still the place to be,” Orlando said.
Stocks were down early in trading on Monday amid concerns of rising interest rates and, in the US, a wait over the next stimulus package to be voted on by the US House of Representatives later this week. The S&P 500 dropped a little under one per cent last week, while the tech-heavy NASDAQ fell 1.6 per cent. The S&P/TSX Composite ended last week down 0.4 per cent.
The benchmark ten-year US treasury yield stood at about 0.5 per cent as of last summer and rose to about 1.0 per cent by the close of 2020. That’s still low compared to where it was before the pandemic-related market pullback last February and March when the yield was at 1.6 per cent. But even that was historically low as the yield has been falling steadily for decades. After the economic crisis of 2008-09, it stood at about 3.5 per cent.
Orlando said this earnings season has been a bit of a surprise, with companies posting growth rather than showing declines at the tail end of 2020. As a result, he’s calling for stocks to end 2021 up a further 20 per cent.
“We’re about 80 per cent of the way through the S&P 500 earnings season, and the consensus going in was that earnings would be down something like nine or ten per cent year-over-year. Well, guess what, earnings are actually up five to six per cent and companies are beating consensus estimates by about 17 or 18 per cent — that’s the third best beat rate on record, trailing only the second quarter in the third quarter of last year,” Orlando said.
“So, the numbers are coming in better than expected and they’ve been doing that now for a couple of quarters,” he said. “We think that trend continues over the course of this year. That suggests that, in our view, stocks are going to be up 20 per cent, up to about the 4500 level by the end of the year. We think the longer-term view is still a very constructive one.”
At the same time, while technology stocks like Amazon, Netflix, Google and Facebook led the charge in last summer’s market rally, Orlando thinks there’s less upside to the sector as a whole going into 2021.
“Last March, we thought that technology was going to lead us out of the abyss and it did, but frankly I think it moved too quickly. By the time we got to the middle of August last year, technology stocks in our view had gotten ahead of themselves,” Orlando said.
“We took tech down from overweight to neutral and rotated to three other areas that had been left for dead: domestic large cap value, small cap and international, particularly emerging markets and small- and mid-cap stocks,” Orlando said. “Those three sectors have outperformed growth stocks over the last four or five months and we think that trend is going to continue over the balance of the year.”
“There’s still a big gap there, a lot of catch-up to play. We think the fundamentals are strong and investors are going to look for that valuation to balance and and put some money to work in those three categories,” he said.
For the fourth quarter 2020, Amazon handily beat analysts’ estimates, reporting earnings of $14.09 per share versus the expected $7.23 per share on revenue of $125.56 billion compared to the expected $119.7 billion. Netflix’s Q4 had better than forecasted revenue at $6.64 billion versus the consensus $6.626 billion, while EPS was a miss at $1.19 per share versus the Street’s $1.39 per share. Both Alphabet, Google’s parent company, and Facebook beat top and bottom estimates in their fourth quarters.