From the desk of Steve Strazza @Sstrazza and Ian Culley @Ianculley
We’re finally starting to see resolutions in the bond market.
The 30-year yield is back above 2.00%, the 10-year has reclaimed 1.40%, and the 5-year yield has cleared 1.00% for the first time since February 2020.
Now that it appears rates have picked a direction, what are the implications for the other two major asset classes, stocks and commodities?
As we highlighted last week, we want to look at cyclical and value stocks along with economically sensitive commodities, specifically energy and base metals.
And, in case you haven’t heard, higher yields should also put a bid in financials.
Today, we want to follow the same train of thought but apply the analysis to Broker-Dealers $IAI.
Here’s the chart of the 10-year 3-month treasury spread overlaid with the IAI/SPY ratio:
The spread between the 10-year and 3-month yields is incredibly important to the large investment banks and broker-dealers that make up IAI.
Like banks, these financial institutions hold many assets on deposit, whereby they pay interest based on the shorter end of the curve. On the other hand, their lending practices tend to earn them a much higher yield.
As such, a wider 10s/3s spread means higher profits and higher prices for these stocks.
It’s also important to remember that yields are coming off historic lows. So, while bigger spreads and rates can become a concern for risk assets eventually, this move is just getting started.
Seriously, after all these years, can we just let financials enjoy some good times? We think they’re ready for exactly that.
In our opinion, a widening in this spread, at this point, speaks more to rates rising across the curve. It's normal and healthy to see the long end move faster than the short end in a rising rate environment.
So, what’s all this mean for broker-dealer stocks for the foreseeable future? Notice how the spread bottomed ahead of IAI several years back. And as the spread has risen in the time since, so have these stocks relative to the broader market.
Then rates paused and pulled back earlier this year. Around that same time, IAI started moving sideways relative to the overall market.
Now that rates and yield spreads are starting to rise again, should we expect IAI to reassert some of that old leadership?
We don’t see why not. This is a group we definitely want to be focused on for long opportunities in the coming weeks and months.
We always want to pay close attention to the critical information presented by the bond market. We’ll keep you updated as the data changes, but for now, it’s looking like we’re entering a rising rate environment...
