Stock Watch in the US market: Decode the U.S. long-term interest rates! Which US individual stocks should you buy now?
Interpret the U.S. long-term interest rates! Which U.S. individual stocks should you buy now?
The Dow Jones Industrial Average fell to 32,899 points at the close last Friday, down 98 points. With caution about the Federal Reserve’s tightening policy growing, concerns over a slowdown in the economy due to continued lockdowns in China also dampened market sentiment, spreading selling mainly in consumer-related stocks.
Consumer-related stocks such as Nike, Walmart, and American Express fell sharply. Walt Disney also traded lower. Even some tech giants like Salesforce and Amazon were weighed down by the rise in U.S. long-term interest rates. On the other hand, energy stocks such as Exxon and defensive names such as Verizon held up. In our paid newsletter, energy stocks like PBF Energy rose as well. PBF Energy surged 50.7% in a month and a half since publication.
U.S. long-term interest rates were at 3.13% as of last Friday, and moved to 3.14% at the start of this week, a high not seen since 2018. In response, the U.S. stock market has continued to show soft performance. The ongoing lockdowns in China, heightening global growth concerns, have contributed to this trend, but the core driver of selling in equities is the growing concern about U.S. monetary tightening reflected in rising long-term rates.
When interest rates rise, a company’s borrowing costs rise as well, which can dampen investment, leading to stock selling. This is the basic relationship between rates and stock prices. So why are U.S. long-term rates rising so much?
The backdrop is inflation in the United States, prompting expectations of monetary tightening by the Fed.
After years of global monetary easing, markets became flush with liquidity, and the value of money declines while the value of what money can buy—prices—rises relatively. The problem is that prices in the United States are rising especially too much.
Extreme inflation can trigger a recession. Yet the glut of money from expansive easing continues, and the strong U.S. job market, along with Ukraine-related or Russia-related sanctions that push up resource prices, further accelerates inflation.
To avoid a recession caused by rising inflation, the Fed intends to tighten policy (hawkish stance). Tightening means raising interest rates and reducing the amount of money in circulation (quantitative tightening, balance-sheet reduction) to curb the economy and suppress excessive price increases.
However, current inflation is running at historically high levels, and a usual pace of tightening is unlikely to be enough. Therefore the Fed plans a rapid pace of tightening. The recent 0.50% rate hike at the FOMC is an example. The Fed is signaling continued aggressive rate hikes, with expectations for not only 0.50% (two times the usual) but even a 0.75% hike (three times the usual).
Yet if the pace of tightening is misjudged, markets can become unsettled, increasing recession risk. If rate hikes are too aggressive, the economy could cool excessively; if they are insufficient or ineffective, inflation may not subside, also potentially leading to a recession. A very delicate balancing act is required for the Fed’s policy—cooling the economy without cooling it too much or overheating it—or so markets believe.
Amid this, the sharp moves in U.S. long-term rates have been a source of market disruption, with U.S. stocks declining through last Friday and U.S. stock indices futures in Asia trading sharply lower today. The market is particularly watching the high levels of U.S. long-term rates.
Stocks to buy now: energy stocks and growth stocks with stable earnings
Last Friday, consumer-related stocks such as Nike, Walmart, and AmEx were all sold off in the U.S. market. Even some tech names, which tend to be more vulnerable to higher rates, such as Salesforce, fell. The Dow fell modestly by 98 points, but earlier the day had seen a sharp drop, and the weekly high-low range approached −1,500 dollars at one point.
The burden on stock prices is, as described above, the rise in U.S. long-term rates. So why are U.S. long-term rates rising? Because the U.S. economy is currently strong, and markets anticipate policy rates to rise to this level in the future.
In other words, even if the Fed tightens, the market believes inflation will not subside until policy rates reach such high levels. If rate hikes continue at a rapid pace and stock prices keep falling, that is the worst-case scenario that markets fear.
However, even in such circumstances, there are still stocks being bought. A representative group is defensive stocks. These tend to be undervalued relative to earnings expectations, and during rising-rate environments they look even more attractive, making them likely to be bought in the current conditions.
Energy stocks and other energy areas are also attracting more buyers, as rising commodity prices can improve profit margins. In addition, even within tech, stocks with stable earnings outlooks are being purchased. At the end of last week, Apple, a leader in smartphones, was a notable example.
With the Fed pivoting its policy, the landscape of the U.S. stock market has changed dramatically. Many high-growth tech stocks led by GAFAM are now, except for stable names like Apple, exposed to lower-price risk. Meanwhile, the “boring” defensive stocks that have steadily risen in price are attracting attention as potential market supporters in this uncertain financial environment this year.
Dollar-yen and Japanese stock market: dollar strength remains, Japanese equities face headwinds
In the FX market, the dollar-yen pair continues to strengthen. Today, ahead of the FOMC, dollar-yen has already surpassed the pre-FOMC high of 131.25 and remains firm around a 20-year high.
As shown above, the United States must accelerate rate hikes, and U.S. rate hikes directly support dollar buying. In addition, in Japan, prices have not risen, and the Bank of Japan must continue monetary easing, which acts as a yen-selling factor.
As noted in this series several times, there is little reason to sell the dollar-yen now, and 131 yen is only a waypoint. Some market participants see the near-term upside cap around 135 yen.
On the other hand, reaching that level will likely require several waves of adjustment selling. For now, around 132 yen seems to be the near-term ceiling.
Regarding Japanese stocks, they have followed the tone of U.S. markets and opened the week with a significant drop on Monday the 9th. However, lately there have been cases where the previously close correlation with U.S. stock markets has broken down, and depending on the details of corporate earnings announced, foreign demand buying at attractive valuations could push the market higher.
Japanese stocks also show that defensive, energy, and stable-earning names remain among the favored targets for selective buying.
