By Hussein Sayed, Chief Market Strategist at FXTM
Concerns over rising inflation have been dominating Wall Street and the financial markets over the past few weeks. Most stocks in growth sectors with overstretched valuations have seen a double-digit plunge in prices and some have even erased more than a third of their market cap.
Tesla Inc, Zoom Video Communications and Peloton Interactive are examples of familiar names that have dropped more than 30% from their highs. While one reason has been attributed to economies returning to pre-Covid habits, the other big factor is rising inflation and bond yields which makes these growth stocks less attractive in investors’ portfolios.
Those fears abated significantly on Wednesday as the market passed two crucial tests.
When stripping out food and energy, core consumer prices in the US increased 0.4% in February, after rising 0.3% in January and 1.3% on a year-on-year basis. The data showed that a feared spike in prices has not materialised, at least for now.
The second test was an auction of new US Treasury debt as investors were concerned that the $38 billion sale of 10-year notes wouldn’t be met by strong demand. However, the auction had a solid bid-to-cover ratio of 2.38 and priced at 10 basis points below this year’s high at 1.52%.
The debt auctions so far this week have shown that investors are comfortable with current rates and Thursday’s $24 billion sale of 30-year bonds will test investor’s appetite for even longer durations.
Given that President Joe Biden’s $1.9 trillion Covid-19 relief bill cleared its final stages on Wednesday, the issuance of new government debt is expected to rise above the $3.6 trillion issued in 2020. This should keep yields rising from current levels, but it is the momentum of the rise that will impact equities.
We continue to favour value stocks overgrowth and see prolonged high volatility in “Big Tech” names with risks tilted to the downside in the short term. Not only will higher interest rates lead to the outperformance of value companies, but it is also the optimism surrounding the economy reopening.
That is not to say that all growth names will be out of favour, but investors need to be selective and take valuations into serious consideration.
From a tactical perspective, to tilt portfolios more into cyclical sectors may benefit the most from returning to pre-Covid ways of living.
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