Investors continue to drive down stock valuations as inter…

Stocks are falling due to rising interest rates and oil prices, as well as profit losses from major financial institutions like Goldman Sachs. The 2-year Treasury yield closed above 1%, signaling that the Fed may need to be more aggressive in raising rates. Mergers and acquisitions news has rallies at Citrix and Activision. Investors are repricing stocks as rising interest rates change price targets.



5 minute read

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Key points to remember

  • Stocks fall on rising interest rates and oil prices plus a rare Goldman Sachs failure

  • Monday merger drops to Tuesday after extended bank holiday weekend

  • Investors are forced to reassess valuations when interest rates rise

JJ Kinahan, Chief Market Strategist, TD Ameritrade

(Tuesday market close) Rising interest rates and oil prices, with some failures from big financials like Goldman Sachs (GS), appear to have been too much for investors who were selling stocks on Tuesday. The VIX (Cboe Market Volatility Index) rebounded 18.76% to 22.79, reflecting heightened investor uncertainty surrounding financial markets. the S&P500 (SPX) fell 1.84% as investors sold shares. However, investors were also selling bonds, causing the 10-year Treasury yield (TNX) up 5.25% to 1.865%. In contrast, the 10-year yield closed at 1.343% on December 3, 2021, its recent low.

One asset investors seem to be buying is crude oil. Oil prices rose 2.74%, surpassing its November 2021 highs and setting a new seven-year high. Rising oil prices appeared to help energy stocks, which were the best performing sector as all other sectors ended in the red. Rising rates normally help financial stocks, but they were the worst performing sector of the day due to earnings losses.

the 2-year Treasury yield also exceeded the 1% mark. Some investors may see this as a sign that the Fed is going to raise rates more than Chairman Jerome Powell originally expected. After the December Fed meeting, Chairman Powell said the Fed was targeting 0.90% by the end of 2022. The 2-year yield tends to be the most correlated to Fed moves, that is, is why investors are now eyeing the potential that the Fed may need to raise rates higher and sooner. The CME FedWatch Tool is currently pricing in a 91.6% chance that the Fed will raise the policy rate by a quarter point in March.

Despite the massive sell-off, some stocks were moving on news about mergers and acquisitions. Bloomberg reported that Citrix (CTXS) may be a target for Elliott Investment Management and Vista Equity Partners. The news sent Citrix up 5.43%. ActivisionBlizzard (ATVI) rebounded 25.88% after agreeing to be acquired by Microsoft (MSFT) for $68.7 billion.

After the bell J.B. Hunt (JBHT) and Bank of America (BAC) are two of the largest companies reporting earnings. Wednesday morning, UnitedHealth (UNH) and Morgan Stanley (MS) are two of the companies expected to announce before the market opens.

The evaluation variable

When interest rates reach a certain level, many investors reassess their investments and change their price targets. This is because equity valuation tools like the discounted future cash flow model use interest rates to help determine a company’s intrinsic value. Intrinsic value is a measure of the value of a business or an asset. The model looks at the growth rate of a company’s earnings over a period of time, then discounts those earnings to present value dollars using the “risk-free” rate of return, which is typically the 10-year Treasury yield. The higher the yield, the less that future income is worth.

But the 10-year yield is not the only factor that can change valuations. Rising business costs like inflation and rising borrowing costs due to higher interest rates could also lower the estimate of future earnings growth or reduce the price multiple that investors are willing to take. to pay for the action. There are other variables at play when calculating intrinsic value, but interest rates are important.

Valuations are probably the main driver helping the S&P 500 Pure Value Index recent outperformance of S&P 500 Pure Growth Index. On November 19, 2021, the value index surpassed the growth index in relative strength. Since then, the value index has risen by more than 8%, while the growth index has fallen by almost 14%. The S&P 500 also fell just over 2% over the same period. And, apparently, investors are finding the most value in energy stocks because the Energy Selection Sector Index increased by 20% in the same period.

CHART OF THE DAY: TARGET RATES. The 10-year Treasury yield (TNX) has broken above its 2021 highs and may not find resistance until the 20 or 2% range. Data sources: ICE, S&P Dow Jones indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Soft ground

My technical analysis friends tell me that we can use long-term charts to get an idea of ​​how interest rates might rise further. The 10-year Treasury yield recently broke above its 2021 highs or resistance. The next level of resistance is likely around the 2% level. Depending on how long it takes for the yield to reach resistance, this could mean more volatility for stocks in the short term.

Of course, rising yields also mean that the bond market will likely continue to fall, as bond prices and bond yields move in opposite directions. However, rising yields will eventually attract income investors from other assets that pay higher dividends, such as utility stocks or real estate investment trusts (REITs). This is because the higher Treasury yields and safety associated with government bonds tend to be more attractive to income investors. Over the past three months, we have seen this play out. the Utilities Select sector index rose about 10%, but peaked early in the new year and fell more than 4%. Likewise, the Real estate sector selection index had risen around 13% at the start of the new year, but is now down around 7.5%.

The housing market could also be struggling as the 30-year mortgage rate is generally correlated to the 10-year Treasury yield. The average 30-year fixed-rate mortgage in the United States closed last Thursday at 3.45%, according to FRED. The 30-year mortgage bottomed on January 7, 2021 at 2.65%. According to SFGate, a 0.25% increase in a mortgage rate could add about $20 to the monthly payment for every $100,000 on the loan. Of course, with the homebuilder backlog accumulating, a little less heat could be welcomed by homebuilders and their suppliers, which is one of the reasons the Fed is raising rates.

good trade,

not a word

@TDAJJKinahan

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