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The Yield Problem

Written by Briton Ryle
Posted March 15, 2021

If you read my editorial for Wealth Daily from last Monday, you know I was expecting the selling to ease and that it was time to look for upside plays. So what happened? Of course, we got a powerful rally the very next day.

Just kidding. That’s not exactly what I wrote. Yes, I said it was time to look for some upside, but I also said that I expected volatility to remain until the Fed meeting this week (March 16–17). And who knows? Maybe the Fed can put the brakes on the careening Nasdaq.

Because in case you missed it, the S&P 500 made a new high on Friday. It is acting as you might expect an index to act just ahead of an economic boom.

It is not often that you will see the S&P 500 hit new highs while the Nasdaq sits 5% below its highs. And that dichotomy became even more glaring Friday when the Nasdaq lost another 78 points. 

Truth is... it may not be all sunshine and unicorns going forward — at least for tech stocks

The Bond Bind

Now, the thing about many tech stocks is that they aren’t as sensitive to the economic cycle as, say, retail or oil. Are you going to search Google more when the economy is rolling? Are you more apt to buy Microsoft Office when the unemployment rate is falling? 

Maybe incrementally, but one could just as easily argue that people will spend less time on Facebook and Twitter once we can get back to something like “normal” life. Those Pelotons will be expensive coat racks as we get outside on bikes that actually move.

Tech companies are more dependent on bond sales than other, more traditional companies. Apple, for instance, uses bond sales to fund share purchases and dividend payments so it doesn’t have to dip into its cash hoard. So all else being equal, if interest rates rise, it will cost these companies more to sell bonds. And that will eat into profits and change the valuation outlook.

Of course, I’d tell you that Apple has a good chance to buck this trend. After all, it is sitting at the start of what should be a massive upgrade super-cycle for phones. Slowly but surely, high-speed 5G service is rolling out, which means just about everybody in the U.S. has to get a new 5G-compatible phone. (There are some windfall 5G investment opportunities that have been ignored in the COVID age. As vaccine rollouts flip the script, 5G will be the major investment theme in the second half of the year. Here’s the best way to play it.)

Still, there is a case to be made that bond yields are rising not because of inflation or the expected surge in economic growth, but because of something a bit more sinister.

Cash Poor

The scary secret that the Fed and the government don’t want to tell you is that it's getting harder to sell Treasury bonds because there’s just not enough money in the world to go around. 

Think about it: Every central bank on the planet has some kind of QE asset purchasing going on. And every government is selling bonds to fund stimulus efforts. I mean, that $1.9 trillion the U.S. government is about to spend has to come from somewhere.

And everybody knows rates have to rise at some point. Even if it’s a couple of years down the road, it still means that if you buy Treasuries now, it’s highly likely you’ll be sitting on a loss in a couple of years. The Treasury has to price its auctions “aggressively,” which is a nice way of saying that it has to lower the price and raise the yield. This means rates may stay strong regardless of the outlook for inflation. 

Also, it’s tax-selling season. In 2020, capital gains were huge — $1.64 trillion. No doubt some investors have already sold stock to pay the taxman. There will probably be more.

And finally, Q1 is over at the end of March. That could be a selling event too. 

Seems to me that stocks could be on the weak side for a few more weeks regardless of what the Fed says on Wednesday. So the game plan is to get your wishlist together and there should be some good opportunity after the market digests the Fed’s comments on Wednesday.

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.

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