Why are stocks reacting to rates?

Genevieve Signoret

(Hay una versión en español de este artículo aquí.)

Lately we have shared our view that, currently, yields on long-term U.S. Treasuries were driving stock prices.

Why would that be?

We like the way Warren Pies, who agrees with us, laid out the answer in an interview with Jack Farley on Farley’s podcast Forward Guidance. Pies listed the three essential reasons:

1. Rollovers. Outside of “the Magnificent 7” mega-stocks (Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia, and Tesla), Pies reminds us, corporations that list their shares on the stock market “must access capital markets.” Because “eventually they’re going to have to roll over their debt.” Barring a select few companies, he goes on, “the rest of the universe and small caps especially are reliant on capital and debt markets for financing, and these rates blow up business models across the board.”
2. Collapsed premia. No company, Ries warns, not even the Magnificent 7, are immune to the negative valuation response to rising rates. When U.S. Treasury rates rise, the equity risk premium—the excess return the stock market pays over the risk-free Treasury rate—“collapses”. And, while it’s true that forward earnings estimates have improved, they “have not risen enough to offset this.” With the result that “even these mega-cap stocks that in some ways do benefit because they have a big cash hoard on their balance sheets are not immune to this.” Ries attributes the fact that mega-cap stocks started selling off on July 31 despite their strong quarter-two earnings reports in part to the harm that rising rates do to valuations.
3. Rebalancing. With bond valuations so depressed, percentage allocations to equity relative to fixed income at pension funds and other “structural asset allocators” (such as myself) “are on a multi-decade high”, so that, “with the yield on a 10-year U.S. Treasury note at 5%, you’re going to get a rotation from stocks to bonds” as allocators systematically rebalance their portfolios.