almost 3 years ago • 1 min
It’s been a notable week for US government bonds – a.k.a. Treasuries – which saw yields rise sharply as investors sold in anticipation of inflation returning to more normal levels.
And, as the chart above shows, when Treasury yields (in blue) increase, US value stocks – those that are cheap compared to profits or assets – tend to climb relative to US growth stocks – those with faster growing revenue. The pink line plots this relative performance by dividing the Russell 1000 Value Index by the Russell 1000 Growth Index.
While this return to more “normal” levels for bond yields and inflation expectations could well be a good thing for the stock market overall in the medium term, it’s causing plenty of short-term pain in those parts of the market most reliant on ultra-low yields. Higher Treasury yields reduce the theoretical present value of future profits in tools like the discounted cash flow model, which is why they hit growth stocks harder.
As this chart from investment bank Societe Generale shows, declining bond yields have been a major driver of price-to-book valuations in some parts of the stock market in recent years. So it shouldn’t come as too much of a surprise if that trend reserves when yields rise.
Treasury yields could well start falling again, of course, but if you think yields will climb further from here it might be time to consider selling some growth stocks in favor of value.
After all, as asset manager Algebris told Bloomberg this week, “bond yields are still well below where they should be versus inflation and growth.”
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