Good economic news is now bad news for stocks as rising interest rates take hold

Trader Talk

There’s a new stock market story in town: Strength in the U.S. economy is morphing into a yield story.

It’s not that surprising. What is surprising is that it took so long to develop. Some have been waiting for years for rates to rise.

What’s up with these rising yields?

1. Very strong U.S. economic data have been building for a while, but the September ISM Services Report on Wednesday caused 10-year yields to shoot up from about 3.08 percent to a high of 3.18 percent before easing back down. Thursday’s data on August factory orders showed the largest increase in 11 years.

2. The Federal Reserve is signaling higher rates. Chairman Jerome Powell recently said, “very accommodative policy is no longer appropriate in the current environment.”

3. Trade fears are subsiding. Yields have been on a modest upswing since trade fears began subsiding in early September.

To a certain extent, higher yields are already affecting the stock market. Interest-rate-sensitive sectors have been generally down for the past month even as the broader markets have hit new highs.

(1 month)

Home construction: down 9.2 percent

REITs: down 5.4 percent

Utilities: down 1.5 percent

Source: CNBC

The rise in yields is most notable in the U.S., but to a certain extent it has also become a global phenomenon.

(highest since)

U.S.: 2011

Japan Dec 2016

Germany: May 2018

France: May 2018

Spain: May 2018

Source: CNBC

Just how far it will go is an open question. We don’t know, but in the past several days, volumes in widely traded Treasury ETFs like the iShares 7-10 year Treasury Bond ETF (IEF) and the iShares 20+ Year Treasury Bond ETF (TLT) have been the highest in months. Options activity has also been high.

It’s not surprising. When risk-free assets like Treasurys have a big move like we have seen, traders sit up and take notice.

Another ETF to keep an eye on is the iShares iBoxx Investment Grade Corporate Bond ETF (LQD), a basket of corporate bonds, which is at its lowest level since early 2016.

Watch for any changes in the spread between corporate bond yields and comparable Treasury yields, says Adrian Miller at Luxemark Capital.

“The corporate market doesn’t typically respond in knee-jerk fashion to sudden changes in bond yields,” he told me. “Only if the run-up in rates looks sustainable will you see spreads react and corporate funding costs increase.”

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