We’ve seen a lot of media interest in this topic, and a lot of articles, many of which seem to generate more questions than answers. With this week’s eLetter we will attempt to correct some of that imbalance.

As a big fat generalization, the primary ‘either / or’ questions asked by investors is stocks vs bonds and then, when the answer is stocks, the question advances to ‘Growth’ or ‘Value’.

Recently stocks have been migrating to the Value side. The primary driver of that action is rising interest rates. When rates are rising, it is harder for Growth stocks to perform because they have the additional challenges of outperforming inflation.

Now, keep in mind that interest rates have been exceptionally low for quite some time. In that environment, Growth stocks enjoy the advantage.

For example, if your targeted stock return is at least 3% more than bonds, and the 10-year bond is returning 5% (remember- not all that long ago), you will invest in a stock if you believe you can get a return of 8 or more percent.  On the other hand, if bonds are returning more like the current 1.5%, then you’ll invest in a stock that you expect to return 4.5%.  You will accept a higher stock valuation which means a lower dividend yield and lower return from the stock.  Even a 4.5% expected return beats the heck out of the 1.5% treasury yield.

Things run into a problem, however, when interest rates go sideways or especially when they start going up.

Outside of the US, the lower interest rates have affected markets in slightly different ways.  For example, in several European countries and Canada, the lower rates have supported their real estate valuations more than equity valuations partly because local investors have been tending to invest much of their capital into the US growth stocks.

Here in the US investors tend to have more equity holdings, and the rest of the world has been buying US stocks as well, with the result that US equity valuations have grown more than our housing values.  Compared to much of the rest of the world, home prices are not expensive here, but our stock market has grown much more, generally.

Because growth stocks then are more sensitive to rising rates than value stocks (and our S&P500 Index* has grown more growth-oriented over the past 10 years than many international markets), our markets are more vulnerable to the rising rates than many non-US markets which are relatively more value-oriented.  As inflation appears to be picking up, there is a natural movement away from growth stocks toward value.  As investors lighten up on growth, the prices of growth stocks will come down.

Ron’s Market Minute — A lot of Bears Coming out of the Woodwork

Positive news: when sentiment turns heavily negative, it’s usually about time for a relative low in markets, with a bounce to follow.  What prompts me to say that is listening to all of the negative comments this morning in the media.

We’ve been seeing strength daily at the open this week, followed by selling later in the day.  Just the opposite of what we’d like to see to showcase some market strength.  And there has been a LOT of computer (automatic) selling this week. 

But there’s a bright spot on the horizon; high-yield bond spreads. They are definitely NOT widening vs treasury bonds (as one would expect when the markets are fearful).  As a matter of fact, spreads are not even as wide as they were in the fall. It would be very Untypical to see a major market decline without the high yield markets showing earlier, significant damage. Not impossible of course, but not very likely either. 

Major indexes are not acting very well. Large-Cap value and Dow stocks holding up the best. In the sector world energy, staples, utilities, and materials are the strongest.  We don’t like to see the defensive sectors as the strongest; it’s not a healthy sign, but then it’s not a death knell either.

We’re holding very defensive positions for now.  

Ronald P. Denk, CFP®
Investment Advisor
Denk Strategic Wealth Partners
10000 N. 31st Avenue, Suite C-262
Phoenix, AZ 85051
Phone (602) 252-8700
Fax (602) 252-8701
Toll-Free (877) The-Denk


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