Volatility Roars Back

The surging 10-Year Treasury yield spooks tech investors … watch out for Evergrande default volatility… another debt ceiling showdown

 

It’s like when you’re flying, feel a few jolts of turbulence, then see the “seatbelt” sign flash on.

Investors are experiencing some market turbulence – and buckling up is probably a good idea.

There are three things troubling markets right now. Let’s look at them to get a sense for how significant they might be.

As I write Tuesday morning, the markets are deep in the red thanks to the soaring 10-Year Treasury yield.

After falling under 1.2% in early August, the yield on the 10-Year Treasury has been pushing higher over the last two months.

That “push” turned into a full-blown “leap” last week, as the yield jumped from roughly 1.3% to over 1.5% as I write.

I’ve circled this one-week spike of about 18% on the chart below.

Chart of the 10 Year Treasury yield spiking about 18% over the last week
Source: MarketWatch.com

This is significant because the yield on the 10-Year Treasury is a major barometer for how traders are feeling about the market and inflation-risk.

A rising yield also serves as a major headwind for technology stocks. Given this, it’s no wonder that our hypergrowth tech expert, Luke Lango, has been monitoring this surge.

From Luke’s Early Stage Investor update yesterday:

The 10-year Treasury yield broke above 1.5% today, continuing its sharpest ascent since February.

Yields have now risen about 20 basis points since the Fed’s meeting last week, as investors are bracing for the Treasury market’s biggest buyer to become a seller before year-end.

This move makes sense, and more importantly, it’s nothing to worry about.

***Why Luke is urging a levelheaded response

Luke points out that while yields might have further to climb, they should return to lower levels due to a handful of reasons.

Back to Luke with those details:

The fact of the matter is that yields were too low, so now they’re correcting higher, but they won’t go much higher from here because there are structural forces in place that will keep them lower for longer.

For one, you have secular deflationary pressures via the expansion and improvement of productivity-boosting and cost-reducing technologies, like automation, artificial intelligence, and virtualization platforms.

For another, you have persistently strong demand for risk-free assets from risk-adverse funds like pension funds – in a market where “cash is trash” and valuations are a bit too stretched to attract major allocations from these risk-adverse funds.

You also have the fact that the labor market will face long-term headwinds from automation technology threatening to disrupt large swaths of the labor market. That will put a floor on how low the unemployment rate can go, which will keep the Fed on the sidelines.

Not to mention, the Fed serves the U.S. government, and the U.S. government has accumulated a lot of debt over the past few years (especially the past 24 months) … so, in order to keep interest payments low for its “boss,” the Fed is incentivized to keep rates lower for longer. Same with every other central bank in the world, for that matter.

Long story short, there are simply too many secular forces at play here for yields to rise much higher. Make no mistake. They will move higher. But at a very slow and gradual pace

The second reason why Luke isn’t alarmed by the yield spike is because he’s focusing on what matters – the long-term growth story, along with earnings.

Back to Luke:

Near-term movements in the yield curve will dictate near-term price action.

But the long-term value of our stocks will be driven by the long-term earnings growth trajectories of our companies.

So long as our companies produce lots of earnings over the next few years, our stocks will move higher – regardless of where yields end up.

Even though the long-term is what matters, for now, the short-term is volatile – and painful. But Luke stresses this is a temporary problem that’s actually an opportunity:

All in all, things look great.

Let the yield volatility resolve itself in the coming weeks. Let tech stocks chop around. Buy the dip when the volatility settles.

Let’s move on to the second source of today’s volatility.

***The threat of a broader fallout from Evergrande is also worrying investors

Let’s begin with yesterday’s update from our Strategic Trader team of John Jagerson and Wade Hansen:

The Evergrande situation in China is continuing to put traders on edge.

A default seems very likely, and most of the world’s major financial institutions have material direct or indirect exposure to that risk.

To make sure we’re all on the same page, Evergrande is an enormous Chinese real estate company that is failing to meet its debt payments.

Last Thursday, the troubled company missed an $84 million payment. It owes another $47.5 million tomorrow.

The broader fear is that this could be a “Lehman Brothers” meltdown for China. Real estate makes up roughly 30% of the Chinese GDP, so a collapse would have a very real impact on their broader economy. It’s reported that Evergrande alone helps sustain more than 3.8 million jobs each year (directly employing about 200,000).

Yesterday, legendary investor, Louis Navellier, also updated his Accelerated Profits subscribers on this situation. Here he is speaking to this broader fear:

A housing bust would have a pretty big impact on the Chinese economy.

Some economists are even predicting that if Evergrande fails, it could cause China to slip into a recession — and, of course, these fears are part of the reason why the stock market sold off hard last Monday.

The good news is neither Louis nor our Strategic Trader team believe significant economic contagion from a default will reach the U.S. However, we could be in for market volatility. Given this, it’s impacting where John and Wade will be looking for trade set-ups.

Back to their update on this note:

We should be cleareyed about the risks and potential for volatility as we get closer to 3rd quarter earnings season in October.

We expect volatility to rise, and we don’t plan on targeting any trades in energy or basic materials, but we also don’t see much risk of a major drawdown yet.

As I write Tuesday, the latest news is that Beijing is urging government-owned property developers to buy up some of Evergrande’s assets. So, it’s not a direct bailout, though it’s a bailout.

From Reuters:

Authorities are hoping, however, that asset purchases will ward off or at least mitigate any social unrest that could occur if Evergrande were to suffer a messy collapse, they said, declining to be identified due to the sensitivity of the matter.

We’ll update you as events unfold here, but don’t be surprised if markets suffer another mini-panic if we get bad news from China.

***Finally, partisan politics could upset markets

The debt ceiling deadline is this Friday.

Last night, Senate Republicans voted against a House-backed bill that would have suspended the debt limit. They objected to how the bill was attached to a broader spending bill pushed by Democrats.

From Bloomberg:

Without a shift in position by one of the two parties, the decision to combine the temporary funding measure and the debt ceiling leaves the U.S. on course for a government shutdown and defaults on federal payments as soon as next month.

According to the Bipartisan Policy Center, without a suspension or raising of the ceiling, there will be a risk of default between Oct. 15 and Nov. 4.

Moody’s Analytics suggests that a prolonged shutdown, were it to happen, would cause another recession, destroying approximately $15 trillion in household wealth and 6 million jobs.

Our politicians are aware of this and don’t want to be responsible, so what we’re seeing is partisan brinksmanship. However, the closer we get to Friday without that solution, the greater the risk of more market volatility.

But remember, we saw this in 2011, when the debt ceiling showdown led to a downgrade in U.S. AAA sovereign credit, and again in 2018 as U.S./China trade tensions were growing. Both times brought plenty of anxious hand-wringing, yet both times we moved past it.

Bottom-line, fasten your seatbelt as these three issues work themselves out. It could get worse before it gets better – but it will get better.

Have a good evening,

Jeff Remsburg


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