Advertisement

This year's market, explained in one chart

This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Wednesday, July 21, 2021

Growth, value, and rates — all in one place

It was a Turnaround Tuesday on Wall Street yesterday.

After a brutal sell-off to start the week, each of the major averages gained nearly 2% on the week's second trading day. A solid rebound after a decline in markets on Monday that perhaps felt worse than it really was.

But Tuesday's market action also served as a textbook example of the biggest trend we've seen sweeping markets over the last few months: waxing and waning confidence in the "reflation trade" that powered markets higher through the first part of the year.

ADVERTISEMENT

The reflation trade essentially calls for higher interest rates due to faster economic growth. As part of this trade, in the stock market we see sectors like Financials (XLF), Materials (XLB), and Industrials (XLI) outperform Technology (XLK), small caps beat large caps, and value besting growth.

And while these trends can seem to be throwing a lot at the wall, Jonas Goltermann at Capital Economics put these themes together in one clean chart. Published in a note to clients on Tuesday, the firm's senior economist highlighted the relative performance of the Nasdaq (^IXIC) against the Russell 2000 (^RUT) compared to the yield on the 10-year Treasury.

The simplest way to think about this chart is that when investors are more upbeat about the economy, they are less excited about tech stocks and vice versa. In many ways, this chart can tell the entirety of any one day's market story.

The relationship between growth stocks and Treasury yields has been at the center of making sense of financial markets moves in the COVID era. (Source: Capital Economics)
The relationship between growth stocks and Treasury yields has been at the center of making sense of financial markets moves in the COVID era. (Source: Capital Economics)

"The recent shifts in equity markets more generally are at least broadly consistent with the risk-off tone in bond and currency markets," Goltermann wrote. "Overall, they suggest a wider reassessment of the 'reflation trade' is now well underway, driven by growing concerns about the strength of the economic recovery amid the renewed spread of COVID-19."

Goltermann noted the 10-year Treasury bond yield (^TNX) and the outperformance of small caps have given back about half the gains they saw this past winter — when we were at "peak reflation" amid hopes for faster growth, a swift vaccine rollout, and broad vaccine uptake at highs.

"Given the renewed uncertainty about the pandemic and the extent to which that may hold back the economic recovery, that may not seem unreasonable," Goltermann added.

The future of this relationship, of course, is no sure thing.

On Tuesday, the Russell 2000 outperformed the three major averages, rising almost 3% versus a 1.57% gain for the Nasdaq. The 10-year yield, meanwhile, settled at 1.21% after hitting 1.15% earlier in the session.

Exactly as we'd expect — rates up, value up.

But we've seen an increasing number of economists in our inbox argue that a more downbeat outlook for growth in the near-term should send yields higher, because this would delay a policy change from the Federal Reserve. An argument that essentially calls for the Nasdaq and the 10-year yield to start trading in tandem rather than inversely.

But before anyone can try to predict what happens next in markets, we have to be clear about what's happening today. And this chart helps everything make sense.

By Myles Udland, reporter and anchor for Yahoo Finance Live. Follow him at @MylesUdland

Yahoo Finance Plus
Try Yahoo Finance Plus now.

Yahoo Finance Highlights

Bezos thanks Amazon customers who 'paid' for space flight, sparking criticism from Sen. Warren and AOC

Delta variant: ‘A perfect storm is brewing’ in certain parts America, health official explains

Bed Bath & Beyond CEO unveils revamped nearly 100,000-square-foot NYC flagship store

Read the latest financial and business news from Yahoo Finance

Read the latest cryptocurrency and bitcoin news from Yahoo Finance