Market Volatility: Schwab’s Quick Take

What happened?

  • U.S. stocks fell sharply Thursday as Treasury bond yields rose. The 10-year Treasury yield hit an intraday high of 1.6%, 23 basis points higher than the previous day’s close and its highest reading in more than a year. At 1.6%, the 10-year yield was higher than the 1.5% dividend yield on the S&P 500.
  • All 11 equity sectors declined. Previous outperformers—Consumer Discretionary, Information Technology, and Communication Services—were Thursday’s worst performers. Defensive sectors—Utilities, Consumer Staples, and Health Care—were relative outperformers.
  • The S&P declined 2.5%. The Dow Jones Industrial Average’s losses were less severe at -1.7%, given its lower weighting to technology and growth stocks. The Nasdaq and Russell 2000 suffered more significant losses—each were down more than 3.5%. The Nasdaq is now down about 7% from its recent all-time high.

 

What is Schwab’s point of view on the impact to bonds?

  • The rise was likely due to a number of issues, including a historically weak 7-year Treasury note auction, an already rising trend in yields due to the improving growth outlook, and large mortgage-backed securities investors likely selling Treasury holdings to hedge their risk. 
  • Yields may continue to move higher despite Thursday’s sharp rise. 
  • Lower-rated bonds could be at risk if financial conditions tighten because of higher yields. Higher borrowing costs pose a risk for highly leveraged corporations whose profits may still be recovering from the pandemic-induced slowdown.

 

What is Schwab’s point of view on the impact to U.S. stocks?

  • The market’s recent success had also led to increased speculative fervor, which is a risk. Heightened optimism doesn’t necessarily indicate an imminent down move, particularly when there is no negative catalyst. However, rising bond yields appeared to be just such a catalyst.
  • Higher bond yields tend to put downward pressure on equity multiples. Richly valued growth sectors are now under the most pressure. With 4Q 2020 earnings season winding down, there will be less earnings growth visibility in the near term, so this pressure may continue.
  • Equity investors continue to re-evaluate their expectations for economic growth and Federal Reserve policy, along with the potential for another round of fiscal stimulus and the effectiveness of the COVID-19 vaccine rollout.

 

What is Schwab’s point of view on the impact to interest rates?

  • The Fed is still likely to keep rates low for a few years. Despite the surge in yields, the Federal Reserve is still focused on meeting its inflation and employment goals. While a stronger rebound in the labor market or inflation could hasten the Fed’s liftoff date, it’s unlikely to raise rates in 2021.
  • The Fed could use other tools to stem the surge in long-term Treasury yields. If necessary, the Fed could alter its quantitative easing (QE) program to shift the makeup of its bond purchases and focus more on long-term bonds. Fed officials have generally not indicated a need for that just yet.
  • Interest rates for consumer loans, such as auto loans and business loans, should remain low. Mortgage rates, which are generally tied to long-term Treasury yields, could continue to rise modestly if long-term Treasury yields keep climbing.

 

What is Schwab’s point of view on the impact to global stocks?

  • International stocks outperformed Thursday due to a higher weight to financial stocks, which tend to benefit from higher rates. International markets tend to be more cyclical in nature and are likely to outperform as global economies recover and inflation rises.
  • International stocks have not experienced the same degree of speculation that U.S. stocks have, and have a lower overall valuation than U.S. stocks. A higher dividend yield and less exposure to aggressive growth names relative to U.S. stocks also helped.

 

What is the takeaway for long-term investors?

  • Make sure your portfolio, and each account, is consistent with your goals, risk tolerance, and preferences. If you’re uncomfortable with market volatility and have short-term goals, make sure you don’t have too much invested in risk assets, and that you have a plan to meet cash-flow needs.
  • Revisit your goals and objectives. If you don’t have a plan, or if it hasn’t been updated in a while, now would be good time to develop one.
  • Don’t try to time the market. It rarely works, and it’s especially difficult to try to time the market around unexpected geopolitical events, like COVID-19.

 

What is the takeaway for traders?

  • Thursday’s selloff put the S&P 500 very close to its intraday low from earlier this week, yet it remains nearly 3% higher in February. The Nasdaq Composite is near negative territory for the month, as rising interest rates and inflation expectations pressure the technology sector, which has been a relatively strong outperformer (+41%) over the past 12 months.
  • Technical support is being tested. The S&P 500 stopped just short of touching its 50-day simple moving average (SMA) of 3,805 for the second time this week. The Nasdaq Composite broke through its 50-day SMA of 13,286 for the second time this week, this time closing below it. Both indices remain moderately positive year to date.
  • Volatility rose this week. The Cboe Volatility Index (VIX) rose 36% on Thursday to close above 29, and moved above its 50-, 100- and 200-day SMAs for the first time in three weeks. At its current level, the VIX is implying daily moves in the S&P 500 index of 60 points per day in either direction.
  • Speculative retail activity sparked a resurgence in the popular Reddit (/wallstreetbets) names after nearly three weeks of declines, even as the broader market fell.
  • Equity traders should consider reducing average share size and dollar amounts per trade and consider slightly increasing their stop loss % levels in the near term.

About the author

Schwab Center for Financial Research