James Mackintosh, writing in The Wall Street Journal, explains that as the term premium rises on bonds, hardest hit could be the so-called “acronym stocks,” also known as the FAANGs. With rates on Treasuries rising, the discounted future profits of these tech giants look less attractive to investors. Mackintosh gives investors in the FAANGs three reasons to worry, writing:
There are three reasons to worry. The first is that the acronym stocks— Facebook, Amazon, Apple, Google parent Alphabet, Netflix, Microsoft and others arranged into the FANGs, FAAMGs and so on—flew too high, and will now fall hard. They were propelled higher by strong fundamentals and helped by low bond yields making profits far in the future look attractive by comparison. If rising yields have broken their upward momentum, it might turn into a downward spiral as investors try to cash in their paper profits on the acronym stocks before they vanish.
The second reason for concern is that if the term premium keeps going up, the acronym stocks should keep suffering as a result. A simple return of the term premium to where it stood three years ago, just before the Fed rate rises began, could power 10-year yields to 3.75%; a return to what used to count as normal would take it well above 4%. Discount future profits back to today at a higher interest rate and they are worth less, and that hits rapidly growing companies more than the rest of the market because more (in some cases all) of their profits are far in the future.
The third worry is that the stock market already was looking unhealthy. Since the start of September, smaller companies have been having a terrible time and bank stocks have fallen sharply. Both suggest a lack of confidence in the economic outlook. The overall market was held up by the performance of a relatively small number of large stocks in high-growth sectors, so if they stumble, the outlook is grim.
More important than the possible breakdown of speculative stocks is the potential realignment of the market into recognizing the value in other sector. Mackintosh continues later:
A shift back to value would be a welcome recognition that the future of the economy doesn’t rest with just a handful of companies. The last really big example of a rising term premium and uncertainty also worked out OK for stocks: In the 2013 taper tantrum, the term premium and yields rose further and faster than they have recently, and U.S. stocks made back their losses within a month.
Read more here.
Jeremy Jones, CFA
Latest posts by Jeremy Jones, CFA (see all)
- Can China Restore Confidence in the Heat of a Trade War? - October 19, 2018
- A Story of Retail Dominance Ends - October 18, 2018
- The Four Stocks Propping up Global Equity Markets - October 16, 2018