Stocks struggle for direction as bond yields surge
Last week saw risk assets climb, with the S&P 500 gaining 1.6% as investors rushed to buy the latest dip in equities. The better than expected U.S. January jobs report and overall positive earnings encouraged risk-taking. Still, as we saw with Meta Platforms, any miss has been heavily punished, with the Facebook owner losing more than $250 billion in value in one day, which is so far is the biggest wipeout in history.
On a macro level, the most exciting development was the shrinking amount of negative-yielding debt across the world. The amount of bonds trading at a negative yield has collapsed from more than $18 trillion at the height of the pandemic to $6 trillion last week. This was helped by ECB’s Christine Lagarde, who refused to rule out tightening policy this year and finally admitted that inflation risks were tilted to the upside. The ECB is now seen following in the Fed’s and BoE’s footsteps towards the withdrawal of monetary stimulus, which sent the euro to an 11-week high against the dollar before giving up some gains.
Equity investors cannot ignore the move in bond yields as most stock prices are derived from them. However, predicting where bond yields will end in one- or two-years’ time is tricky as many factors can change. Markets are convinced that the Federal Reserve will raise interest rates five times this year, but they see the tightening cycle ending with rates below 2%. This implies that either a risk of recession will force the Fed to change course or inflation will get under control over the next several months.
The U.S. consumer price index due on Thursday is expected to have risen 0.5% in January, with the year-on-year change hitting a new four decade high of 7.3%. Core CPI, which excludes the volatile components of inflation like energy and food, is also forecast to rise 0.5% compared to 0.6% in December. These reports will be scrutinised to see which parts of the economy remain hot and whether there are any signs of prices cooling down. Hence, expect volatility to remain elevated over the upcoming few days.
This week is also another busy one on the earnings front, with 76 S&P 500 companies set to release Q4 results. Any disappointment from a company whose valuation is high will lead to a severe reaction. Pfizer, Walt Disney, Uber, Nvidia, and Twitter are some of the familiar names that investors need to keep an eye on.