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The stock market has a ‘real’ problem: Morning Brief

This is The Takeaway from today’s Morning Brief, you can to register delivered to your inbox every morning along with:

Last week, my colleague Brian Sozzi argued that technology stocks had developed a performance problem.

It’s actually even worse: all stocks have a yield problem. And more than just a yield problem, stocks have a “real” yield problem right now.

Over the past week, investors have focused more on rising real returns, or inflation-adjusted returns.

The yield on 10-year TIPS — Treasury Inflation-Protected Securities — rose 2.2% on Monday, the highest since March 2009.

Unlike most Treasury bills, bills and bonds, which pay a fixed interest on a fixed principal, TIPS principal can fluctuate over time.

As the Bespoke Investment Group team wrote in an email Monday, “On paper, higher real yields represent market prices of higher policy rates relative to inflation, and thus a stronger economy.”

And while some of the market’s focus on TIPS in recent days, we think, can be attributed to the calendar β€” there are fewer market catalysts at the end of August than, say, mid-May β€” there’s no question that investors are grappling with the economic crisis. story of the summer: a resilient US economy.

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As Yahoo Finance’s Josh Schafer reported Monday, economists are now focused on looming upside risks to inflation from a strong labor market, rising wages and consumer spending.

For the stock market, higher interest rates mean lower stock prices, all else being equal. In a note to clients on Sunday evening, Fundstrat’s Tom Lee wrote a clear explanation of how his clients see these dynamics weighing on the markets right now.

β€œIn our many conversations with institutional investors over the past week, the vast majority cite the increase in interest rates as the most concerning concern for equities. It makes sense. The increase in interest rates means that the P/E multiple is coming under pressure. stand,” Lee wrote.

“The US 50 basis point 10-year increase to 4.255% is a 7% P/E hit … and this is about the S&P 500 hit,” Lee added. “And higher stocks would be hit disproportionately, which explains why FAANG/Tech have been hit harder with Nasdaq 100 -7% lower.”

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As for what’s driving 10-year rates up, Lee said clients are “baffled” with policy actions in China and Japan, a higher budget deficit in the US and Nick Timiraos’ article in The Wall Street Journal this weekend, all appearing in the ” possible reason” camp.

But we think the movement in real yields that accompanies a rise in nominal government bond yields suggests that more than anything else, this movement has to do with what is fundamentally happening in the US economy: a longer-term shift. of low interest rates than the market thought.

“The sale [in Treasuries] led by a rise in real rates as traders reassess the likelihood of a higher neutral rate, in line with recent research from the New York Federal Reserve, and what that could mean for the longer-term outlook for Fed policy ,” John Canavan, principal analyst at Oxford Economics, wrote in a note to clients on Friday.

“While expectations for additional interest rate hikes this year remain low and stable, there is a shift in expectations for future rate cuts.”

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