The 2021 Equity Equation: It’s All About Interest Rates

The NASDAQ gave us a hint about what it thinks of the bond market’s sell-off when it tumbled from 14,095 to 12,609 over 16 sessions in February and March. 

The primary catalyst was a backup in the 10-Year Treasury yield by a half percentage point or so. The yield has stabilized a bit since then and the NASDAQ has found footing in recent weeks, but what if the 10-Year note decides to take another run at 2%?

There is a clear focus in this market. If I could write it in an equation, it would be:

Rising Rates = Growth Stocks “Off” + Value Stocks “On”

It has to do with interest rate sensitivity. The NASDAQ is loaded with a ton of companies that promise distant profits. It is currently accorded a trailing P/E of 73 and a forward P/E of 34.6, and the sudden spike in rates catalyzed the net present value math on its components to morph a pot of gold into tin.

Figure 1: NASDAQ Composite

Figure 1_NASDAQ Composite

Amid the NASDAQ’s stumble, it would have been reasonable for the S&P 500 Value Index to have sold off in sympathy. Yet that did not happen. Value stocks were so down and out over the last generation that rising rates are breathing new life into them—the index is clawing its way to new highs above 1,400, having closed 2020 at 1,267.

The concern for the NASDAQ and other growth-oriented indexes is that many seers believe the fixed income sell-off must certainly be overdone, and that settling into current yields must be imminent. Once the market digests these new interest rates, goes the refrain, the NASDAQ can get on with its raging bull market once more.

That assumes that these new “high” yields are viewed as a juicy opportunity. Before you stew on that, a quick reminder: the Street consensus is for a federal budget deficit of 14.3% of GDP this year, some of the deepest red ink in the world.

But it will be all over once Covid-19 goes away, back to balanced budgets, right? Not even close.

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