Susan McGee
PROVIDENCE, R.I., May 17 (Reuters) – High-flying U.S. stocks have yet to price in a surge in inflation and are vulnerable to a sharp surge in bond yields, investors warned.
Stocks were driven by expectations of strong first-quarter earnings and a boost from artificial intelligence, masking risks from high energy prices and an ongoing war with Iran.
But a spike in bond market yields over the past week — with the 30-year Treasury yielding more than 5% and the benchmark 10-year bond yielding more than 4.5% — could change things for investors. This led to caution in the stock market on Friday.
Paul Karger, co-founder and managing partner of TwinFocus, which manages money for ultra-high-net-worth families, said every time he meets with clients, his clients ask him questions about how to make sense of apparent market paradoxes.
“Breakfast, lunch and dinner: the question is always how to make sense of the fact that the outlook is so divergent,” Kaag said. Earnings told a positive story, but oil prices and inflation were negative for the business.
Karger adopts what he calls a “barbell” strategy for the assets he manages: amassing large overweight positions in cash, gold and other commodities while maintaining positions in market-leading mega-cap growth stocks.
Following the outbreak of the war between the United States, Israel and Iran at the end of February, the U.S. stock index experienced an initial downturn and then rebounded sharply. The benchmark S&P 500 index was last up more than 17% since hitting year-to-date lows in late March, and despite a pullback of nearly 1% on Friday, its year-to-date gain is still more than 8%.
Rising benchmark yields tend to put pressure on stock valuations as businesses and consumers face higher borrowing costs. It would also impact economic growth and corporate profits, while potentially making bond returns more competitive than stocks.
This is especially true now with the stock market at its highs. As of Thursday, the benchmark S&P 500 was trading on 21.3 times forecast earnings for the next 12 months, according to LSEG Datastream. That’s well above the index’s long-term average forward P/E ratio of 16, although below the 23.5 level reached in October, as a stronger U.S. earnings outlook helps keep valuations in check somewhat.
“I do think there is a real concern that inflation is going to be entrenched in the economy going forward,” said Peter Tooze, president of Chase Investment Advisors in Charlottesville, Virginia. “You don’t see any signs of a decline right now and that’s a real concern and if that continues, it’s going to drive the market lower.”
