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Yields Are Moving Up, But So Is Volatility

3/3/2022

Yields are on the move up. Here's what stock investors need to know.

In February 2022, yields moved higher in response to anticipated monetary tightening. The yield on the two-year Treasury, which is more sensitive to Fed policy expectations, increased to 1.56% in the wake of the CPI report, registering its sharpest one-day move since 2009 and up from 0.73% at year end. The yield on the 10-year Treasury also breached 2% for the first time since mid-2019 after ending 2020 at 1.52%.

The sharp rise in yields has contributed to market volatility, particularly for stocks whose value comes from anticipated earnings far in the future, as those earnings get discounted to a lower present value. This has resulted in value stocks outperforming growth stocks. Through mid-February, the Russell 1000 Value Index has outperformed the Russell 1000 Growth index by 9%. Multiples have come down given the selloff to start the year, which is to be expected with higher interest rates. The forward P/E for the S&P 500 is now just under 20x, down from the 21.5x entering the year.

From an earnings perspective, things look reasonably good even if growth is expected to slow. EPS growth for the S&P 500 in 2021 is expected to register approximately 47%, with 26% growth in Q4. Given more challenging comparisons, EPS growth in the first quarter is anticipated to slow to 5% with full-year consensus estimates reflecting a greater than 8% increase. As a result of the pandemic, there are many companies either overearning or underearning relative to what they would generate in a normalized environment. This presents both opportunities and potential traps.

Overlay a Fed that is determined to tighten conditions, and a focus on fundamentals becomes even more important. In contrast to the speculative frenzy that took hold of markets in early 2021, the current backdrop is one that should favor companies with solid and improving fundamentals like those we cover in each issue of the Investor Advisory Service. This is definitely an environment we prefer.


Reprinted from the March 2022 issue of the Investor Advisory Service stock newsletter, rated #1 for performance in 2021 by Hulbert Ratings.

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