Trading pattern where lower bond yields help growth stocks is breaking down

Published Thu, Mar 25 20217:08 AM EDTUpdated Thu, Mar 25 20219:05 AM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

The fevered trading pattern where lower bond yields send growth stocks higher and vice versa broke this week, at least temporarily. Yields and growth stocks were lower Wednesday. Whether that signals the trade that's been fairly well correlated since February is unraveling or not is yet to be seen. The 10-year Treasury yield fell to 1.61% on Wednesday, well off last week's high of 1.75%. Recently when yields fell, the Nasdaq typically gained ground. But not this week. The Nasdaq , which is home to tech and many growth stocks and has dropped the most when rates rise, was down 2% Wednesday, lower for a second day, as Treasury yields also fell. Yields move opposite bond prices. "You had rates coming down, and the market still didn't act well, which is a head scratcher," said T3Live partner Scott Redler, who follows the market's short-term technicals. "You need to be careful." Bond strategists have expected a period of falling rates in late March and into early April, as big investors shift money to bonds from stocks in quarter-end reallocation trades. Some strategists expect that might ultimately be good for stocks after the reshuffle is done because yields should be lower. Rick Rieder, BlackRock global fixed income CIO, told CNBC he expects yields will stop rising in the short term but should be higher in a few months. "I just think we're going to pause here for a bit of time," he said. JPMorgan technical analysts say the stock market is consolidating and its decline won't be large. "We believe short-term weakness this time around will be more muted than the late-Feb reaction to that signaling, and we look for the [S & P 500] index to hold 3850-3900," they wrote. "On a medium-term basis, we expect the market to extend to 4074 and 4080-4140 objectives in the second quarter." The JPMorgan analysts also expect the bond yields to pause in their move higher. The Nasdaq Composite slid Wednesday as tech got pummeled, and the S & P 500 was off a half percent at 3,889. The small cap Russell 2000 was hit the hardest, down 2.4%. "The small caps are almost 10% off the highs in two weeks," said Redler, adding that the Nasdaq 100 had already corrected by more than 10% by early March. "Sector by sector has been breaking the momentum trend, and the S & P 500 is hanging on by a thread," said Redler. "Does that thread snap? If it does, volatility can rise." Some technical analysts see the market as consolidating and don't expect to see a sharp fall. Some say lower rates could clear the way for investors to move into tech and growth names again. "I think they're in the process of basing, but you're seeing small caps come off a high level," said Ari Wald, technical analyst at Oppenheimer. "One by one, these areas are taking turns going through the correction process. All through this, there's very little damage to the trend." The S & P 500 already corrected 6% to the 3,723 level on March 4, before turning higher again, but the Nasdaq fell nearly double that rate to 12,599 by March 8. "The March lows for both of those indexes is going to be important," said Wald, adding he expects those levels will hold and act as support. Strategists expect cyclicals and value stocks to continue to outperform, but Wald said the steady nature of Nasdaq has been underappreciated. "If you look at how it's ascended in recent years, it's such a far cry than what occurred in the late 1990s," he said. "Value was so weak in the last few years. ... If there's going to be a convergence, it's going to be value catching up rather than growth catching down. It's really going to be a mix of both." Wald said tech stocks also have the Fed on their side. "At every one-year mark, after a bear market low, at the one-year anniversary, if the Fed hadn't hiked rates yet, techs hit rate going forward improved," he said. "It had a higher chance of outperforming over the next six months." He also believes that because rising rates haven't been a big factor in Nasdaq's consolidation, its correction would naturally be bigger than that of the S & P 500. "If you look back historically, I could point to the doubling of interest rates from 2016 to 2018 when rates went from 1.5% to 3%. Then tech outperformed," he said. "Returns don't get hurt for the growth equities, forward returns don't fall below average until you get the 10-year above 4% historically speaking." Redler said he can see an opening where the FANG stocks start to perform again. The group was lower Wednesday with Facebook down 2.9%, Amazon down 1.6%, Netflix off 2.7% and Alphabet down 0.4%. Apple was also off 2%. "For seven months, FANG has been building and basing. If the market is going to turn up after April, it may be FANG that leads the way, after quarter-end and through the earnings season," said Redler. But if the market doesn't find its footing, the market could be in for some choppy time. "If the S & P starts to roll down and follows the small caps and [Nasdaq], we could be in for some pretty volatile days," said Redler.

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The fevered trading pattern where lower bond yields send growth stocks higher and vice versa broke this week, at least temporarily.

Yields and growth stocks were lower Wednesday. Whether that signals the trade that's been fairly well correlated since February is unraveling or not is yet to be seen. The 10-year Treasury yield fell to 1.61% on Wednesday, well off last week's high of 1.75%.

Recently when yields fell, the Nasdaq typically gained ground. But not this week. The Nasdaq, which is home to tech and many growth stocks and has dropped the most when rates rise, was down 2% Wednesday, lower for a second day, as Treasury yields also fell. Yields move opposite bond prices.