Why a big drop in bond yields ‘freaks people out’ and sends stocks tumbling

Stock market investors were spooked Monday by a sharp move lower in Treasury yields amid growing concern over rising cases of COVID-19 globally, according to Phil Camporeale, a portfolio manager at JPMorgan Chase & Co.

“We’ve come a long way” since the onset of the pandemic, said Camporeale, who is a manager for JPMorgan’s $5 billion Global Allocation Fund, in a phone interview Monday. But “a move lower in rates always freaks people out.”

The 10-year Treasury yield
TMUBMUSD10Y,
1.212%
fell almost 12 basis points Monday to 1.181%, according to Dow Jones Market Data. That’s the biggest one-day drop in yields since March 23, 2020.

JPMorgan’s Global Allocation Fund, which has a multiasset investment strategy, reduced its overweighting to value stocks in June on the “clear signal” from the 10-year Treasury note that yields were declining, according to Camporeale. The drop over the past couple months signaled it was time to “rightsize your value-versus-growth trade,” he said, explaining that value stocks, such as consumer discretionary, financials and energy, tend to do well when rates and growth expectations are rising.

U.S. stocks dropped Monday amid concern over the rising spread of the delta variant of the coronavirus, with the Dow Jones Industrial Average
DJIA,
-2.09%
seeing the steepest decline of the three major benchmarks. The blue-chip gauge fell about 2.1% in the largest daily drop since Oct. 28, 2020, according to Dow Jones Market Data.

Read: Why did the Dow tumble Monday? Economic growth is now a bigger worry than inflation.

The “pro-cyclical” Dow tends to get hurt the most when “the reopening trade is questioned,” whereas the technology-heavy Nasdaq Composite
COMP,
-1.06%
tends to fare better in that environment, according to Camporeale. The Nasdaq fell 1.1% Monday while the S&P 500
SPX,
-1.59%
dropped 1.6%.

“We are still committed to reopening trade, we’ve just trimmed our positions a little bit,” he said, adding the Global Allocation Fund has also cut its underweight to government bonds.

Read: 10-year Treasury yield slides to 5-month low, touches 1.179% as delta spread spooks market

Judging from Treasury yields, concern over the U.S. economic growth may be overblown, according to Camporeale.

The U.S. economy is in better shape than in mid-February, when the 10-year Treasury was trading at a similar level and the vaccination rollout was still in the early stages, according to Camporeale. The majority of Americans over the age of 65 are now fully vaccinated, helping to keep severe cases of Covid-19 and hospitalization rates low, he said, adding that initial jobless claims are now much lower than in February as the economy continues to rebound.

Read: U.S. unemployment claims drop to pandemic low of 360,000, but businesses still struggle to find workers

While Camporeale expects that the U.S. growth rate probably peaked in the second quarter, “that doesn’t mean you go from peak growth to recession,” he said. “We still believe in above-trend GDP growth through the end of this year.”

Scott Wren, senior global market strategist for Wells Fargo Investment Institute, said in an interview Monday that he believes the 10-Treasury yield is too low based on the firm’s outlook for the economy.

Wells Fargo expects the U.S. economy will see “very strong” growth of about 7% this year and that it will increase around 5% in 2022, according to Wren. He said he expects the yield on the 10-year Treasury note could rise to around 2% by the end of this year.

“The potential for lockdowns that would dramatically depress the economy seems like a low probability right now,” Wren said.

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