What We're Seeing: Yields Surge, Risk Off – 1 April 2024

The Week in Brief

Equities gave back some ground last week. The S&P 500 and Nasdaq each slipped roughly 1%, snapping a stretch of strong performance. The culprits were familiar: a surge in Treasury yields and renewed tensions in the Middle East.

Small caps took the hardest hit. The Russell 2000 fell about 2.8%, reflecting classic risk-off positioning. When investors grow nervous, they tend to shed their most volatile holdings first. The rotation we noted last week, where breadth was improving, took a pause.

Sector Divergence

Not everything fell. Energy stocks bucked the trend, hitting record highs as supply concerns pushed crude prices higher. Financials also outperformed, benefiting from the steeper yield curve. Defensive sectors held up relatively well, as one would expect in a cautious tape.

The sector action tells us this was not a broad-based capitulation. It was a repricing driven by rates and geopolitics, with investors shifting toward areas that benefit from those themes rather than fleeing entirely.

Fixed Income Under Pressure

Longer-dated bond yields moved higher, with the 10-year briefly touching 4.5%. The Bloomberg Aggregate was down on the week as bond prices fell. Higher yields reflect a repricing of Fed expectations: the market is now less confident that rate cuts are imminent.

We have been cautious on duration for some time, and last week validated that positioning. Until inflation data convincingly softens or growth slows meaningfully, yields are likely to remain elevated.

Our Read

This feels like a healthy correction rather than the start of something more serious. The pullback was orderly, driven by identifiable factors rather than panic. Equity valuations had stretched in some areas, and a reset was overdue.

We think the bias remains to buy dips rather than sell rallies, but selectivity matters more now. Energy and financials look well-positioned in this environment. Growth stocks, particularly those with stretched valuations and sensitivity to rates, face a tougher path.

The Middle East situation adds a layer of uncertainty that is difficult to handicap. If tensions escalate further, oil could spike and that would be a headwind for consumer spending and corporate margins. We are not making big bets on geopolitical outcomes.

What Could Change Our View

If yields continue to rise sharply from here, the calculus shifts. A 10-year yield above 4.75% or 5% would likely trigger a more meaningful equity correction as discount rates rise. Similarly, if the geopolitical situation deteriorates into something that materially disrupts oil supply, we would need to reassess our relatively constructive stance. For now, we view last week as noise rather than signal.

This is informational commentary, not investment advice.