After enjoying the best kickoff in more than three decades, the S&P 500 posted its biggest decline since 17 August 2017. All ten sectors traded in red territory, suggesting that we didn’t see any rotation, but rather a broad-based selloff that was mainly led by the Energy, Utilities, and Telecom sectors.
The factors that supported the rally over the past couple of months are still in play: global synchronized growth, enthusiasm over the Trump administration’s tax cuts, and strong earnings growth. According to Factset, more than 76% of S&P 500 companies have reported higher-than-expected EPS and 81% have reported positive sales surprises. These figures represent a record high in terms of U.S. companies beating sales estimates.
Given these upbeat results, many investors may consider buying the dips. This strategy has been profitable during the stock market uptrend, so why not buy the dips now?
Few will disagree that valuations are overstretched. However, due to low global interest rates, equities have remained attractive during the past couple of years.
Now with United States 10-Year bond yields trading above 2.7%, and breaking above a three-decade downtrend, the uptrend in equity markets will be under a new test. Not only U.S. interest rates are on the rise, but Germany 5-Year Bund yields moved into positive territory for the first time since December 2015 and Japan's 10-Year yields are trading at a seven-month high.
The rise in global bond yields isn’t necessarily a bad thing; it reflects the strength of the economic recovery. However, the pace of the rise in yields may create significant headwinds for equities in the days to come, especially if U.S 10-year bond yields break above 3%, which represents a very critical physiological level in my opinion. A simple question that may come to investors' mind is “Why would I remain in equities when U.S. 2-Year Treasury bills can provide the same dividend yield return as the S&P 500, at 2.12”?
The CBOE Volatility Index edged up 25% on Monday, the highest close since August last year, suggesting that investors are demanding put options to protect their portfolios from potential downside risks. This combination of higher bond yields and the VIX increase are catalysts for a further correction in the days to come, so keep a close eye on these two indicators.
Disclaimer: The content in this article comprises personal opinions and ideas and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. FXTM, its affiliates, agents, directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness of any information or data made available and assume no liability as to any loss arising from any investment based on the same.
Risk Warning: There is a high level of risk involved with trading leveraged products such as forex and CFDs. You should not risk more than you can afford to lose, it is possible that you may lose more than your initial investment. You should not trade unless you fully understand the true extent of your exposure to the risk of loss. When trading, you must always take into consideration your level of experience. If the risks involved seem unclear to you, please seek independent financial advice.