Growth stocks have rallied as U.S. government bond yields have declined to the lowest levels since February, a trend expected to persist if the economic outlook dims.
The S&P 500 Growth Index, which tracks the large-cap companies in the S&P 500 expected to grow at rates above the market average, has climbed roughly 15% since the end of the first quarter of 2021. The S&P 500 Value index, which tracks the companies in the S&P 500 viewed as trading at a lower price relative to their fundamentals, climbed less than 4.5% over the same time period.
Apple Inc., Microsoft Corp. and Amazon.com Inc., which make up more than 30% of the S&P Growth index's weight and are the index's three largest companies, have all climbed nearly 20%, respectively, from March 31 through July 7.
Berkshire Hathaway Inc., JPMorgan Chase & Co. and The Walt Disney Co., which are the S&P 500 Value's largest companies and make up 7.6% of the index's total weight, have increased by 9.3%, 0.9% and declined by 6.4%, respectively, over the same period of time.
Bond yields have fallen to a recent low for a variety of factors, including disappointing U.S. economic data. The decline in long bond yields has been a boon for growth companies, which rely on lower borrowing costs to help pay for acquisitions, hiring and other future plans. Lower bond yields would lower the discount rate, used to determine the present value of future cash flows.
"A lower discount rate particularly helps growth stocks since their cash flows are farther out in the future," said Sherifa Issifu, associate, index investment strategy, with S&P Dow Jones Indices.
Growth stocks are more reliant on expectations of future profits than value stocks, Issifu said.
Since the end of the first quarter of 2021, the benchmark 10-year Treasury yield has skidded 47 basis points, from a settlement of 1.74% on March 31 to a 1.27% low on July 8. It is the lowest point for the yield, which moves inversely to bond prices, since February.
The 30-year yield has fallen 55 basis points from the end of the first quarter, from 2.43% on March 31 to a low of 1.88% on July 8.
"The overriding concern being reflected in the bond market is that peak growth has been reached, and the benefits from fiscal policy are starting to fade," said Sophie Griffiths, a market analyst with financial services company OANDA.
The potential end of the reflation trade, a decline in commodity prices, and the release of economic data falling below expectations have pushed bond yields lower. One of those economic data points, the July 6 Institute for Supply Management survey of service-oriented business, showed a fall to 60.1% in June, down from a record 64% in May. The survey measures growth in the U.S. services sector.
Antoine Bouvet, a senior rates strategist with ING, said the decline in long bond yields and the flattening of the Treasury yield curve may be a reflection that the market believes that tapering of Fed bond purchases may be further off than initially anticipated due to less-optimistic economic data.
Bouvet, however, holds a different view than the market.
"Inflation is elevated and will prompt the Fed to withdraw accommodative measures, starting with tapering," Bouvet said.
The Fed's minutes of its June meeting showed that some participants expected an easing of the central bank's ultra-loose monetary policy, particularly a tapering of its $120 billion in monthly bond purchases, sooner than expected. The minutes offered no concrete dates for such an easing, and analysts continue to debate the precise timing of a potential policy tightening.
Whether the rally in growth stocks continues depends partly on whether the rally in bond prices continues. In a July 8 note, Tom Essaye, a trader and founder of financial research firm The Sevens Report, said the most recent decline in yields could be due to a wave of short-covering by fund managers. If that is not the case, the rally in growth stocks may just be beginning.
"One thing is clear, if bonds are not trading on short-term positioning, then the 'smart market' is telling us that inflation and growth have already peaked and an economic slowdown, not acceleration, is looming in the back half of the year," Essaye wrote.