Wall St. has a different view apparently! -ng-
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Higher Bond Yields Herald Stock Gains Amid Lessening Inflation
By Michael Tsang and Daniel Hauck
June 25 (Bloomberg) -- Is the five-year stock market rally threatened by the highest bond yields since 2002? Some of the world's biggest investors say no.
LPL Financial Services, Bank of America Corp. and BlackRock Inc., which together oversee $1.9 trillion, say the three-month increase in yields shows investors are selling bonds in anticipation of faster economic growth -- not a pickup in inflation. Their evidence includes falling gold prices and a narrowing trade deficit.
In another sign, yields on 10-year Treasury bonds surpassed those on three-month securities last month for the first time since July. Over the past four decades, the Standard & Poor's 500 Index has posted an average 12-month increase of 9.3 percent after the so-called inverted yield curve ended, according to Birinyi Associates Inc.
``If yields rise because inflation is going up, that's bad news for stocks,'' said Jeffrey Kleintop, who helps oversee $150 billion as chief market strategist at LPL in Boston. ``If they go up because real economic growth is going to be stronger, and consequently profits are going to be improving, that's actually good news for the stock market.''
Kleintop said he favors shares of technology companies, which will benefit from accelerating growth. Computer-related stocks, along with consumer and industrial companies, have been among the best performers whenever long-term yields start to exceed those of shorter-term securities, according to Birinyi.
Bond Yields Jump
Ten-year Treasury yields have jumped 64 basis points, or 0.64 percentage point, from their 2007 low of 4.49 percent on March 7. That helped precipitate a 2.4 percent slide in the S&P 500 from its record on June 4 and heightened speculation that higher financing costs will reduce demand for loans and slow the record pace of mergers and acquisitions.
The yield on the 10-year note reached 5.327 percent on June 13, according to Cantor Fitzgerald LP, as traders stepped up bets the Federal Reserve won't cut interest rates this year. That was the highest since April 2002.
The Fed, which said this month the economy is growing without stoking inflation, will meet this week to discuss monetary policy for the world's biggest economy and announce its decision June 28. The central bank has held its benchmark overnight lending rate at 5.25 percent since June last year, after raising borrowing costs 17 times from a more than four- decade low of 1 percent in June 2004.
`Knee-Jerk Reaction'
The slump in stocks is just a ``knee-jerk reaction'' to higher bond yields and a growing consensus the Fed won't cut rates this year, said Joseph Quinlan, chief market strategist for Bank of America's investment strategy group in New York. U.S. companies will benefit from increasing global trade, boosting economic growth and improving the odds for stock gains, he said.
The trade deficit narrowed by the most in six months in April, the latest report showed, as expanding overseas economies and a cheaper dollar lifted demand for American-made goods.
A gauge of leading U.S. economic indicators, which points to the direction of the economy over the next three to six months, strengthened by a more-than-forecast 0.3 percent in May, the Conference Board's report showed last week. In the first quarter, U.S. gross domestic product expanded at an annual rate of 0.6 percent, the slowest pace of growth in more than four years.
Faster global growth will lure investors to stocks and away from the fixed-interest payments of U.S. debt, according to HSBC Holdings Plc, Europe's largest bank by value.
`All Cylinders'
``The bond market is pricing in a world economy firing on all cylinders,'' said Quinlan at Bank of America, whose investment-management unit oversees about $547 billion. ``It's good for equities.''
Gold prices and inflation-protected Treasuries, or TIPS, support the view that expectations for faster growth, rather than inflation, are driving bond yields higher.
Gold futures fell to $647 an ounce, the lowest price in almost three months, on June 13, the same day 10-year Treasury yields rose to their five-year high. When investors expect inflation to accelerate, they often buy gold as a hedge to protect the value of their assets.
The yield on 10-year TIPS, which pay interest at lower rates than regular Treasuries in return for a principal amount that increases at the same rate as inflation, has increased 57 basis points to 2.69 percent since its 2007 low on March 21.
That's 2.44 percentage points below the yield on regular notes, a difference that represents investors' estimate of inflation over the life of the security. The spread has remained at about the same level over the past 12 months, an indication inflation expectations haven't changed.
History Lesson
The yield curve, which charts the gap between two-year and 10-year debt, returned to its normal steepened configuration this month on signs global growth will enable the U.S. economy to rebound. Two-year note yields had exceeded those of 10-year securities for most of the past year, inverting the yield curve.
An inverted yield curve typically signals an economy that is on the verge of falling into recession.
The yield on 10-year Treasuries surpassed that of two-year notes on June 6, and the advantage climbed to 22 basis points on June 22, the widest since October 2005.
Seven times since 1967 when longer-term yields surpassed three-month bill yields, the S&P 500 fell an average of 3.8 percent the following month, according to Birinyi, a research and investment firm based in Westport, Connecticut.
In those seven cases, the S&P 500 rose an average of more than 9 percent within a year.
Higher yields are ``saying something more about the economy than anything about inflation for me,'' said Kevin Rendino, who runs the $8.6 billion BlackRock Basic Value Fund from Plainsboro, New Jersey.
Healthy Sign
Shares of consumer, technology, and industrial companies are the best bets over the next year, if history is any guide, Birinyi's data show. A gauge of S&P 500 consumer discretionary stocks added an average of 22 percent in the 12 months after the end of the inverted curve, while computer-related shares climbed 21 percent. Industrial companies rose 14 percent, Birinyi said.
Stock investors shouldn't be too quick to disregard the specter of inflation when assessing bond yields, said Stuart Schweitzer at JPMorgan Asset Management in New York.
One interpretation is that the rise represents ``fear that stronger-than-expected growth will translate into stronger-than- expected and stronger-than-desired inflation,'' said Schweitzer, global strategist at JPMorgan, which manages $1.3 trillion. ``We'll be on tenterhooks on that for some time to come.''
Fed's Range
For now, the data show inflation is moderating to within the Fed's preferred range of 1 percent to 2 percent.
Consumer prices, excluding food and energy costs, increased 2.2 percent in May from a year ago, the smallest gain since March 2006. The central bank's preferred gauge, the core personal consumption expenditures price index, rose 2 percent in April, a report showed on June 1. That's the smallest gain in 13 months.
The rise in bond yields ``is a reflection of global growth and not a rebound in inflation,'' said John Skjervem, chief investment officer of the wealth management unit of Chicago- based Northern Trust Corp., which manages $756 billion. The yields aren't ``at a level that's going to derail what are otherwise very constructive conditions for financial markets.''
To contact the reporters on this story: Michael Tsang in New York at mtsang1@bloomberg.net ; Daniel Hauck in New York at dhauck1@bloomberg.net
Last Updated: June 24, 2007 19:03 EDT |
