The Fed ⬆️ rates, this ⬆️ borrowing costs for banks and pretty much everyone else.
The story then unfolds:
Interest rates ⬆️, mortgage and credit card rates ⬆️, disposable income 🔽
S&P500 is down 6.5% since the start of January.
Nasdaq is down over 10%, the Dow 6%.
Why do stocks go down when Treasury yields (i.e. interest rates) go up?
Especially tech stocks!
Thread 👇 🧵
The Fed ⬆️ rates, this ⬆️ borrowing costs for banks and pretty much everyone else.
The story then unfolds:
Interest rates ⬆️, mortgage and credit card rates ⬆️, disposable income 🔽
When you spend less, firms sell less stuff.
This in turn affects company earnings, and by extension their stock prices.
It’s just a way how investors value stocks.
Anticipating what the future cash flow of tech firms is worth today.
And the discount factor reflects interest rates in the economy.
As interest rates go ⬆️ the present value of future earnings goes 🔽
Remember that most tech stocks have very high expected future earnings.
And as a consequence extremely high valuations.
And it hasn't even raised them yet!
Why does that warrant such a big correction?
Sure, the Fed didn’t raise rates yet, but the bond market is adapting to *expectations* of 3 to 4 interest rate hikes this year.
Because as the economy overheats - higher exp. growth & higher inflation - the Fed raises it’s federal funds rate
(short-term interest rates basically)
This sends short-term T-yields ⬆️
(the 1-mo, 2-mo, 3-mo, 6-mo rates)
They expect short-term rates to fall in the future.
So they buy long-term bonds, thus pushing their price down.
(see this thread for an explanation of how this works)
https://t.co/Cd45dlta8K
6/ If there is greater demand for a bond, and its price goes\U0001f53cto, say, $1050, the current yield is 20/1050 = 1.9%
— Vuk Vukovic (@wolf_vukovic) November 15, 2021
If the price of a bond goes\U0001f53bdue to less demand, say to $920, the current yield jumps to 20/920 = 2.17%
Hence the inverted relationship btw bond yields & prices.
So we get an *inverted* yield curve - a self-perpetuating mechanism that sends signals to investors and at the same time drives reactions of market actors.
It becomes a self-fulfilling prophecy.
That's why keep an eye on the spread between the 2 year (& 3-month) yield to the 10 year yield.
Nothing, really.
It depends on the period you look at.
Stocks went down 40% of the time, up 60% of the time.
Coin-toss, really.
In this case, a 50bps rise in rates moved equities by 1 p.p.
Their logic is that higher rates are necessary due to a strong economy, and a strong economy implies better earnings.
Expect sector rotations during corrections: moving from tech to energy or industrials or banks.
Tech? Don’t exit, take some profits and keep holding
(if you have any profits left, that is!)
And also watch out for that yield curve inversion!
Follow me @wolf_vukovic for more similar stuff on finance, markets and investing.
