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Interest Rates May Soon Break Out, And That Is Bad News For Stocks

By Michael KramerStock MarketsDec 04, 2020 09:44AM ET
www.investing.com/analysis/interest-rates-may-soon-break-out-and-that-is-bad-news-for-stocks-200546817
Interest Rates May Soon Break Out, And That Is Bad News For Stocks
By Michael Kramer   |  Dec 04, 2020 09:44AM ET
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This article was written exclusively for Investing.com

Many technology stocks have surged in 2020 as rates have plummeted, and investors have sought safety in their significant revenue and earnings growth rates. Adding extra fuel to the fire was the notion that these stocks posted accelerating growth due to the pandemic. But that trade may now be at the end of the road, as rates slowly creep higher, and expectations are getting tough to beat.

Plenty of these long-term growth stories have fallen apart this week, like Zoom (NASDAQ:ZM), Salesforce (NYSE:CRM), and Splunk (NASDAQ:SPLK), each falling sharply following earnings results

Earnings Yield Game

Salesforce's stock saw its earnings yield, which is the inverse of the P/E ratio, fall to its lowest level since 2018—about 1.4% on Sept. 2. In the chart below, one can see how Salesforce's earnings yield had historically averaged around 1.85%. But as the 10-year rate fell to record low levels, it gave investors the ammunition it needed to push Salesforce's earnings yield lower in an attempt to keep the spread with the 10-year yield around the historical norms which sent the stock price sharply higher.

Salesforce Earnings Yield V 10-year Treasuries
Salesforce Earnings Yield V 10-year Treasuries

It is essential to understand that the earnings yield narrative is partially the driving force behind some of these advances. Because, if stocks have been rising on the concept of lower interest rates making them more attractive, then rising rates likely mean the exact opposite which will send these stocks lower. 

Yields May Rise Sharply

Investors may need to pay attention to this trade now more than ever. Rates on the 10-year may be about to break out, as it is testing a critical downtrend that started in 2018. The only thing standing in the way of rates rising sharply is a level of resistance around 1%. Should the 10-year rate rise above 1%, it could result in a jump up as high as 1.3%. As measured by the relative strength index, momentum is also showing that yields may continue to push higher, with a clear uptrend.

10-year Treasury Yields
10-year Treasury Yields

It isn't just rates that can end the party. It seems that some of these stocks have high valuations, which are now being put to the test. For example, Zoom reported better than expected results earlier this week. However, the stock was still hit hard, falling by more than 15%, on concerns over contracting margins. Splunk is another example of a stock that has performed exceptionally well this year and fell by around 20% after it missed analysts' expectations. 

Exuberance

Perhaps, these stocks have sold off hard because yields have already risen by around 40 basis points since the summer, making holding them difficult. If companies can't deliver the big earnings beats investors have grown to expect, then it makes it harder to justify the lofty multiples investors have given to these stocks. If consensus earnings estimates are not rising at a pace fast enough to offset rising bond yields, then it makes the justification for owning these stocks much more challenging. 

It could just as easily be that investors have finally started to wake up as valuations for some of these companies have simply reached levels where expectations have become too exuberant. Whatever the case may be, it seems pretty clear that some of the exuberance is starting to wear off. 

Interest Rates May Soon Break Out, And That Is Bad News For Stocks
 

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Interest Rates May Soon Break Out, And That Is Bad News For Stocks

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Comments (10)
Steven Angelo
Steven Angelo Dec 06, 2020 6:34AM ET
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Investors will not abandon growth stocks for 1% + yield on a 10 yr. note. After inflation a 1% - 2% yield is zero return. Remember the fed head said they are not even thinking about, thinking about raising rates. This article is terribly misguided and smacks of contrarian bias.
Aditya Aditya
Aditya Aditya Dec 05, 2020 5:21PM ET
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no man growth stocks going much higher..
Chris Floyd
EventHorizon821 Dec 05, 2020 12:43PM ET
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Looking at the 1month not just 1.3, but 1.7 will be tested. It will be critical to drop back down under 1.3 if the trend is to continue otherwise by the measurement 2.06 & 2.35 will be tested after.
Brandon Mclane
Brandon Mclane Dec 05, 2020 10:51AM ET
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If the yeild rises the dollar and bond prices will fall, putting upward pressure on the stocks. Where else would people put their money?
Sam Spoof
Sam Spoof Dec 05, 2020 8:49AM ET
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Shorting the bounces..I participated in SPLK - bought Puts prior to earnings..the rest is history amazing Thw whole idea Michael, is to alert before the drop NOT AFTER the main event already happend..
King Cut
King Cut Dec 05, 2020 8:49AM ET
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How much you made?
Rob Fordham
Rob Fordham Dec 05, 2020 8:26AM ET
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Short term they may pull back longer term their business models will keep growing
Trevor Mead
Trevor Mead Dec 05, 2020 8:15AM ET
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Michael has puts 😔
Justin Cash
justincash Dec 05, 2020 8:13AM ET
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Spot on! Great insight indeed!
Clifton Cockroft
Clifton Cockroft Dec 05, 2020 7:44AM ET
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Nobody should care just buy on red day and don't worry about it
taylor jason
taylor jason Dec 04, 2020 9:42AM ET
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the yield curve is still inverted on the short end. and the long end of the curve is less than 2%. hardly a concern right now considering sp500 e/p is 2.70%. further im guessing you didn't take note of the fed commentary where they mentioned they would be manipulating specific area of the yield curve
taylor jason
taylor jason Dec 04, 2020 9:42AM ET
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https://www.stlouisfed.org/on-the-economy/2020/august/what-yield-curve-control
la popeye
la popeye Dec 04, 2020 9:42AM ET
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manipulation is one thing but the dollar is going down and at one point, printing or manipulation will br exactly what Usa are fighting against. will be like china or it is like china. no more market evaluation but manipulation.
la popeye
la popeye Dec 04, 2020 9:42AM ET
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the writer is right. look at TBT.Slowly and surely usa will have imported high inflation due to falling dollar. And as usa as a big trade deficit, this will come quicker than you think. 3% inflation by mid 2021.
Jeremie Lemieux
Jeremie Lemieux Dec 04, 2020 9:42AM ET
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Powell made it very clear that interest rates are gonna stay a zero for a long time. With yellen back in the game, we are more likely to see negative rates before any hike.
Connor Geoffroy
Connor Geoffroy Dec 04, 2020 9:42AM ET
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Yep I believe Powell stated rates will not change until 2023
 
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