the rocky road to 4%

The 10-year Treasury note started out 2022 with a 1.63% yield. Two days ago, the yield reached 2.97%, before retreating a bit to 2.89% as I’m writing this on Friday morning. This compares with a rise of the Fed Funds rate for overnight bank borrowing of basically zero as the year opened to something slightly south of 50bp today. So, say +50bp vs. +134bp, showing what typically happens in the interaction between the Fed and the bond market–the Fed indicates, the market reacts, and the Fed follows up with moves that validate the bond market response.

My position has been that, after post-pandemic ructions subside and assuming Ukraine won’t get much uglier than it is now, we end up with inflation of 3% and a 10-year Treasury note that yields 3.5% – 4.0%. The most salient point is that rates are going up, so I don’t see any need to fine tune my guess until we get into this range.

I suspect that most professional equity investor hold similar beliefs, and have held them for months. If so, however, why does Wall Street continue to react negatively with each nudge upward in the 10-year, rather than discount the move–to 3.5% at least–all at once.

I have no idea, but in the 40+ years I’ve been involved with stocks, this is what has always occurred. So it’s no surprise that choppy waters is what we’re dealing with now. My guess is that this will be the order of the day for equities at least until we get to 3.5%.

I’m looking at three stocks as bellwethers:

HOOD, which I started buying about a month ago, and which I think is trading at very close to its net asset value–meaning there’s very little, in my view, in the price for its being a going concern. It bottomed with the rest of the market on March 14th, returned to fall slightly below that intraday yesterday, and is trading around the same value as I’m writing. I think that stability in stocks like this will be an early sign that the market is shifting to other ideas than simply rising rates.

ZM, which I don’t own, and which I regard as a stay-at-home stock, will likely struggle in a post-pandemic world. It also bottomed on March 14th but is trading about 6% above that now. Although I’m less optimistic about ZM, I still think that we may again be establishing a price here where the market is already discounting all the bad things that higher rates and a more normal economy may well bring.

W, which I don’t own, has two strikes against it. It’s a stay-at-home stock which is also tied to the housing market–which is likely to be the primary economic casualty of rising interest rates. It bottomed on March 14th, but has resumed its decline over the past week or so. It now trades at almost 20% below its 3/14 close.

What ties all three together is that all are non-tech and each has lost about 3/4 of its peak value. An important early sign of market healing, I think, will be when investors begin to root through rubble like this for stocks that have been sold off too much. It’s still very early, but that may be happening now. I think the most likely direction for the market is still sideways until we get to 3.5% or so, but this kind of bargain hunting would be an encouraging sign.

Leave a Reply

%d bloggers like this: