Making Sense of Yields

Rosy earnings estimates suggest that the economic recovery is on track. The reopening is here and corporate profits are surging. But there's a conflicting metric that no one quite understands. As stocks hit highs, yields on the 10-year Treasury note have been under pressure. The benchmark 10-year note has risen slightly over the last two trading days, but it's still at just 1.36%, down a significant 38 basis points, or 38 hundredths of 1 percent since late March. (Yields fell as low as 1.25% last week.) Falling yields don't jibe with an accelerating economy.

It's all the more confounding given that the Federal Reserve has begun to signal interest rate increases could be on the way sooner rather than later (sooner as in late 2022 rather than later in 2023).

Falling yields has meant that value stocks, which were outperforming earlier in the year, have gone back to lagging behind their growth counterparts. But the value tilt may still win out over the longer term. At least according to strategists at UBS. Here are excerpts from what  Solita Marcelli, chief investment officer for the Americas at UBS Global Wealth Management, wrote to clients today:  

So overall, we believe that the recent 1.25% in 10-year yields is not a function of dwindling fundamentals or an overly hawkish Fed. We continue to view the path of U.S. interest rates as higher over the second half of the year as the recent technical variables fade and the focus shifts back to the overall growth of the economy. ...

Since the move in interest rates and the shifts within equity markets have not altered our outlook for economic growth or for corporate profits, our overall positioning remains intact. Cyclical segments should disproportionately benefit from the economic momentum that we expect to persist over the next year. We think earnings growth for value stocks will meaningfully outpace growth stocks over the next several quarters. Moreover, rising interest rates and a steeper yield curve should benefit financials, the largest value sector. Valuations for value have become even more compelling after their recent pullback—trading at one of the steepest discounts to growth since the dot-com bubble. We believe that rising rates will be a headwind again for growth valuation and longer-duration assets.

If UBS is right, expect value stocks to resume their leadership position in the coming months.