Markets Moving in Lockstep Threaten to Make for a Trying 2024
Summary
The latest angst over stocks and bonds shows three ways that inflation and the economy can move your portfolio.
Some investors hold that as goes January, so goes the year. The performance so far—with the S&P 500 down 1.7% by Thursday’s close—doesn’t hold out great hope. But the first three trading days of the year offered a useful run-through of three of the ways that inflation and the economy affect your portfolio.
The year started the way the last one ended, with all the focus on the Fed and inflation, only in the opposite direction.
Day One. Stocks plunged on Tuesday, the first trading day, as bond yields rose, amid concern that last year’s excitement about impending rate cuts had gone too far. Over the final two months of the year, investors bet big on lower inflation and rapid Federal Reserve easing, lowering bond yields drastically and boosting stock prices. Since 1989, there were bigger eight-week drops in 10-year Treasury yields only amid the crises of 1998, 2008-09 and 2020, so it isn’t surprising that investors had second thoughts about the size of the swing.
What’s unusual is bond yields and stocks moving in opposite directions—at least it was unusual until recently. The 90-day correlation between moves in the S&P and the 10-year Treasury yield is about as negative as it’s been this century, as the focus on inflation pushes them in opposite directions more often than any time since investors concluded that Alan Greenspan’s Fed had conquered inflation.
To understand Tuesday’s markets, and the rest of the week, we have to think about how the economy affects stocks and bonds. A stronger economy normally brings both higher profits (good for stocks) and more inflationary pressure, and thus higher interest rates (bad for stocks). Sometimes the higher profits more than offset the higher rates, and stocks and bond yields rise in tandem—as they did from 2000 to 2020 most of the time.
From October to the end of the year, investors concluded that inflation was coming down by itself, so they could have both nice profits and lower rates—a doubly good thing that pushed up stocks 15% in eight weeks. When some of the confidence in rate cuts evaporated on Tuesday, there was no offsetting good news on the economy, so stocks fell.
The stocks most affected by higher bond yields should be growth stocks, which have their profits farther out in the future. Sure enough, on Tuesday they had their worst day since the run-up began in October, with the Russell 1000 Growth Index down 1.5%. Cheap, or value, stocks that are less sensitive to rates—and rose less in recent months—eked out a small gain.
Day Two. Wednesday brought a different dynamic, as economic news came in better than expected, initially pushing Treasury yields up sharply to above 4%. There were more job openings than economists predicted, and the Institute for Supply Management manufacturing report was less bad than forecast. Higher bond yields were again bad for stocks, the pattern of the past couple of months, as higher potential for profit wasn’t enough to offset higher rates—before the minutes of the Fed’s December meeting came out and bond yields ended the day down, along with stocks.
Day Three. On Thursday, markets initially returned to the model we’ve all grown to love, as stocks rose along with Treasury yields on the back of a stronger-than-expected jobs market and good news from the services sector. This is the correlation investors want; sure, higher bond yields hurt the Treasurys in our portfolios but we make much more on stocks. Treasurys are pesky things to hold in good times, but the point is to hold them in case of bad times. At least they now offer a yield above inflation.
Later in the day, the good news faded. True, more members of the S&P 500 were up than down, but bigger stocks dragged down the overall index. Perhaps shareholders were spooked by the 10-year yield again reaching 4%. Or perhaps, after the fantastic run-up, anyone with any sense is selling to take profits each time stocks go up.
None of this offers us much of a clue to the direction of markets for the rest of the year. What we can wish for is less concern about inflation, more certainty about what the Fed will do and so more days where stocks and bond yields rise in tandem.
Unfortunately, I expect an intense focus on inflation and the Fed for the next few months, even if the Fed does go through with a rate cut in March as investors hope. That creates trouble for those of us who like to hold Treasurys as a cushion against bad times in our portfolios, because it’s likely that day-to-day we’ll make or lose money on stocks and bonds at the same time—that is, higher bond yields will be bad for stocks, and lower yields good for stocks.
Of course, if we’re making money on both stocks and bonds none of us will care, but days like Tuesday when both lose have been distressingly common in the past couple of years.
Write to James Mackintosh at james.mackintosh@wsj.com
