American Express Stock – The Reflation Trade Is Stirring Growing Pains in Growth Stocks. Here’s Why.
It stinks to be on the wrong side of the trade. But that’s where many investors find themselves these days—Friday’s rally notwithstanding—when it comes to the reflation trade.
The trade is quite simple. The U.S. economy is heating up—Friday’s payrolls report, which showed a 379,000 increase in jobs, is just the latest example. Inflation expectations are rising, with 10-year Treasury Inflation-Protected Securities, or TIPS, pricing in inflation of 2.24%. Treasury yields keep climbing, with the 10-year finishing the week at 1.551%. And not every index was built for it.
That’s clear from the index returns this past week. The
Dow Jones Industrial Average,
with its bias toward big, economically sensitive companies like
(ticker: CVX) and
(AXP), rose 1.8% on the week, while the more balanced S&P 500, climbed 0.8%. The
home to high-priced growth stocks like
(PYPL), tumbled 2.1%.
Federal Reserve Chairman Jerome Powell, speaking at a Wall Street Journal event Thursday, had a chance to make the pain in these growth stocks go away. He chose not to use it. He didn’t offer any soothing words to suggest that Treasury yields should be lower. There was no talk of yield curve control, or Operation Twist, or even supplementary leverage ratio relief—a technical rule dictating how much capital a bank has to hold, which some want extended. And to make matters worse, Powell doesn’t seem all too bothered by it.
That’s probably by design. Nicholas Colas, co-founder of DataTrek Research, argues that Powell knew exactly what he was doing. He’s letting the market know that higher yields don’t bother him, especially with an additional $1.9 trillion in stimulus winding its way through Congress to keep the economic recovery going. He also knows that this set-up will make the 10-year yield more volatile than ever before.
Already, the 10-year yield has tripled from a low of 0.52% in August. The largest year-over-year increase was 77% in August 2013. And if the volatility persists, the rotation from high-priced growth into cyclically sensitive stocks should continue apace. “Dramatic changes in Fed policy always drive changes in equity investor preferences and therefore what sorts of stocks work,” Colas explains.
Of course, too much volatility could force Powell to react. If junk-bond spreads—the difference in the yield of a high-yield bond and that of an equivalent Treasury—were to widen, a sign of financial stress, Powell would almost certainly find a way to calm the markets. A 20% decline in stocks, too, might force his hand. But junk-bond spreads have barely budged during the recent rise in Treasury yields, and the S&P 500 is down just 2.4% from its high. There’s no sign yet that the selloff is having an impact on financial conditions.
If credit markets can remain calm, the pain may only be starting for the market’s most expensive, (formerly) best-performing stocks, says Christopher Harvey, U.S. equity strategist at Wells Fargo Securities. He screened for stocks that had supersized 12-month returns at the end of 2020, faster relative growth, price/earnings ratios that were more than double that of the Russell 1000, and a minimum market capitalization of $10 billion. Among the stocks that qualified for the basket: Tesla,
Zoom Video Communications
(ZM), all of which fell at least 9% this past week.
The biggest risk for these companies is that there is no ready buyer, if longtime holders become forced sellers. They’re too expensive for value investors—the few of them that are left—and those seeking growth at a reasonable price. And with growth no longer hard to come by, these stocks are likely to continue dropping. “When growth is abundant, and will stay abundant, scarcity value has to shrink,” Harvey says. “That’s why we’re beginning to see the rotation.”
But it’s also why the market might have a tough time going anywhere for a while. The market’s short-term momentum had already started to fade after hitting new highs in mid-February, says Katie Stockton, founder of Fairlead Strategies, and medium-term indicators started to roll over this past week, generating a sell signal on Tuesday, when the
declined 0.8%. Sometimes, that marks the beginning of a major pullback, but other times it simply means that stocks will be choppy for a while. That’s what Stockton expects to happen now. “This is something that’s healthy in steep uptrends,” she says.
And it will give us an opportunity to find the next trade.
Write to Ben Levisohn at Ben.Levisohn@barrons.com