The cost of capital – how much return shareholders and creditors demand for risking their cash – is rising.
That’s essentially what’s happening when treasury yields rise. And rise they have.
The US 10-year yield jumped 74 basis points in the year to October 29, and traded as high as 3.25 per cent earlier in October. That led markets to sell off aggressively.
It’s difficult to tell where the effects of a higher discount rate finished and growth fears for the future began. But both are likely to have had a hand in driving stock markets lower.
As it is, we took the chance to add to both US and UK 10-year sovereign debt as yields spiked in early October.
We are not piling into these bonds, but we thought it prudent to buy when the prices fell, given our positions are pretty light because of the low-rate environment.
The cost of borrowing is just one of several costs that’s increased this year. Brent Crude at $80 is almost a fifth higher than at the beginning of the year, while American wage growth hit a nine-year high in September.
Then there’s a few hundred billion dollars more in tariffs that have been slapped on crossborder commerce involving the US.
President Donald Trump has been vocal in his belief that the Federal Reserve is moving too quickly. As unconventional as Mr Trump’s protests to an independent central bank are, we do have some sympathy for his view here.
While there have been some wild stories about American truckers getting paid $100,000 we think this is one of a few skills shortages, not a general upswing in wages. Pay cheques are growing barely in line with inflation.
We think the Fed must slow down, otherwise it could create a serious setback in the economy and markets.
Earnings have risen considerably this year, but price to earnings ratios have dipped recently. In some respects it’s quite healthy, given the significant upward move in all markets over the past decade.
Although, even as the US economy looks and feels like it’s going gangbusters, investors punish stocks for any misstep, regardless how minor.
The third quarter reporting season is a case in point. Half of the S&P 500 has reported and earnings growth is running at a punchy 22 per cent, according to FactSet.
But looking to the future has become decidedly murky. Almost twice as many companies have released lower sales growth guidance for the final quarter than have issued higher forecasts.
Amazon was probably the most prominent disappointment, warning that the Christmas season will deliver less revenue than first expected.
Even another hefty boost to profits wasn’t enough to placate investors – the shares slumped 10 per cent in a day.
