Taken together, slim bond yields, a gentle Fed and ebbing volatility tend to support or expand equity valuations, even with corporate profits seen going flat in the first half of the year.
Jim Paulsen, chief investment strategist at The Leuthold Group, points out that the markets are responding in concert to an economy coming off a scare over potential overheating and a possible Fed mistake.
“It is not that the bond market knows something the stock market doesn’t,” he argues. “Although Treasury yields often fall and remain lower at the start of a recession, they also frequently decline and remain lower when the valuation of stocks and bonds rise together. Rather than signaling a pending recession, recent action in the Treasury market more likely reflects the common aftermath of a mid-cycle overheat within an ongoing expansion.”
The kinds of stocks gaining favor also fit with a low-yield environment: dividend-rich utilities and real-estate investment trusts are near all-time highs. So is the S&P Invesco 500 Low Volatility ETF (SPLV), which contains more stable companies rather than cyclically geared ones.
And big growth stocks – those promising many years of expected rising cash flows to come – are leading again: The Russell 1000 growth index has outpaced its value counterpart by 1.5 percentage points in the past month. The 52-week high list from Wednesday speaks to this preference, featuring the likes of Mastercard, PayPal, Intuit and American Tower.
All this suggests that the market is not recklessly pricing in a big economic acceleration or earnings snapback that the bond market isn’t. Equities are mostly recovering the nasty downside overshoot of December while investor sentiment and positioning have gradually returned toward a more neutral state.
Low Treasury yields would be a bigger worry for stocks if the yield curve were flattening further, or if corporate bonds were being shunned.
The Treasury yield curve has been narrow but steady this year, between 0.15 and 0.2 percentage points between the 2- and 10-year maturities.
And the risk spreads on high-yield corporate debt have tightened up since December and are back toward November values, which is pretty consistent with the S&P 500 trading back up to early November levels.
All of this helps explain how stocks have managed to rally while yields trend lower. But it doesn’t answer the question of how long it can go on this way, or just how much further lift stocks can derive from a patient Fed and undemanding corporate-debt costs.