What We're Seeing: Win Streak Ends – 27 May 2024

The Week in Brief

The S&P 500’s five-week win streak came to an end. Equities gave back some ground as Treasury yields popped higher after mixed auction results. The bond market reminded investors that rate expectations can shift quickly.

Higher yields clipped long-duration tech and growth stocks, which are most sensitive to discount rate changes. Meanwhile, cyclical and value sectors outperformed. Energy and financials led on the rate volatility, benefiting from themes that work when yields rise.

Bonds in Focus

The bond market saw yields rise across the curve. The 10-year briefly traded above 4.5%, dragging the Bloomberg Aggregate into the red for the week. The move was triggered by tepid demand at Treasury auctions, which raised concerns about supply absorption.

This is a dynamic we expect to see more of. The US fiscal deficit remains large, and the Treasury continues to issue significant amounts of debt. At some point, investors may demand higher yields to absorb the supply. Whether that point is now or later remains to be seen.

Energy Stands Out

The energy sector again stood out, posting gains as crude prices climbed toward their year-to-date highs. OPEC+ discipline, combined with steady demand, has kept oil well-supported. Energy stocks offer a hedge against inflation and geopolitical risk, which may explain their relative strength.

Investors grew cautious ahead of the June Fed meeting. The upcoming gathering will provide fresh projections on rates and the economy, and markets want to see if policymakers acknowledge the recent inflation progress.

Our Read

We view this pullback as a healthy pause rather than the start of a correction. The yield move was notable but not extreme, and equities have held up reasonably well. The rotation from growth to value is playing out as expected when rates rise.

For positioning, we continue to favour a diversified approach. Energy looks well-placed given the supply/demand dynamics and the hedge it provides. Financials benefit from steeper yield curves. On the growth side, we are being selective, focusing on companies with earnings power that can withstand valuation compression.

The bond market deserves attention. If yields continue to climb, it will eventually weigh on equities more meaningfully. The 4.5% level on the 10-year is not disruptive, but 5% might be.

What Could Change Our View

A break above 5% on the 10-year would be concerning for equity valuations. Similarly, if the Fed signals a more hawkish stance at the June meeting, we would need to reassess. On the positive side, softer inflation data would likely cap yields and provide support for risk assets. We are watching the June CPI print closely.

This is informational commentary, not investment advice.