Interest rates have resumed their ascent following a brief summer pause. And, in recent weeks, their climb has accelerated.
Aside from lower bond prices, what do higher rates mean for other assets, such as stocks and commodities?
It might seem like a simple question. But its relevance is undeniable given the current market conditions.
We’ve been vocal about the cyclical areas of the market that benefit most from a rising rate environment – think commodities, energy, materials, and banks. We’ve put out plenty of trade ideas in those areas.
Higher rates mean downside pressure for long-duration assets in general, not just bonds. This also includes growth stocks!
Check out the chart of the US Treasury Bond ETF $TLT overlaid with the growth-versus-value ratio:
These two charts tend to have a strong positive correlation. The lower pane highlights this strong relationship with a 21-day correlation study.
Given the tight relationship between these two markets, the fresh lows in TLT suggest further underperformance for growth relative to value.
Will we see the hardest-hit areas of the market sell-off in the coming weeks?
It’s possible.
These fresh lows for bonds not only suggest further underperformance for growth stocks but also continued weakness on absolute terms. If this key ratio undercuts its May lows, it's probably because the weakest names are leading the market lower.
The Ark Innovation ETF $ARKK is an excellent example. Here’s a chart overlaying it with TLT:
We like to use ARKK as a proxy for growth stocks, given its heavy weighting toward mega-cap tech and communication names. This chart is long-duration asset central.
Notice how TLT and ARKK both bottomed during the same week in June.
These assets don't perform well when rates are rising. It’s that simple. When rates stop going up, ARKK and TLT stop going down.
As long as TLT is trading below its June pivot lows, ARKK is vulnerable to increased selling pressure and another leg lower.
How bonds react at current levels will indicate the higher probability outcome for growth stocks. If bulls can step in and repair the damage in Treasuries, it would go a long way for ARKK and other long-duration assets.
On the other hand, if TLT continues to slide, we imagine ARKK will follow. And the major averages would remain under pressure due to their heavy weighting toward growth.
That’s why it’s crucial to pay close attention to the bond market and interest rates in particular. The direction yields take in the coming weeks will provide critical insight into the major market themes leading into year’s end.
Stay tuned!
Countdown to FOMC
Following Powell's most recent comments, the market is pricing in a 75-basis-point hike later this month.
Here are the target rate probabilities based on fed funds futures:
