Rotation out of Treasuries Accelerates

Brian Hilyard
Money and Investing Writer

Treasury yields rise because investors are rotating out of them and into riskier assets like equities. However, that was not the case this week. (Photo courtesy of Karolina Grabowska)

Major indexes faltered this week while Treasury Yields soared. The 10Y Treasury yield has passed 1.3%. In theory, these two should move in the same direction. Treasury yields rise because investors are rotating out of them and into riskier assets like equities. This is known as risk-on.

At first, it seemed as though this money from selling Treasuries ended up in Bitcoin, now above $50,000, it ended up in sectors with smaller weights in the SPX and NASDAQ.

Financials and Energy rose 3.39% and 4.61% last week, respectively. Industrials also rose, up 1%. These sectors were battered in 2020, and the risk-on mindset stems from the belief that the economy is on the path to recovery.

Something to keep in mind is that rising interest rates exert downwards pressure on equity value multiples. As fixed income returns rise, it makes equities less attractive from a risk-return point of view. The S&P 500’s average P/E ratio is at an all-time high of 31.9x. It is usually in the range between 15x and 20x.

With equity value multiples being so frothy already, we should approach equities with some caution. On one side, we are expecting earnings to recover sharply, growing into current valuations. This could mean, however, that equity prices will plateau over the next 12 months.

On the other side of the coin, analysts have been calling for a sharp recovery in earnings before vaccine distribution started. With distribution behind schedule, especially in the US, it puts that thesis at risk, as the companies that will see the sharpest recovery in earnings had them battered by the lockdowns. We even have new strains starting to spread.

While it may be too early still to commit a large portion of your portfolio in industrials and materials, keep them on your radar so you can buy in when uncertainty is removed from the table. For now, I am comfortable in continuing to invest in big tech, financials, and consumer staples such as Coca-Cola, PepsiCo, etc.


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