Stocks Retreat After Monday’s Rally

Dow: -0.46% | Nasdaq: -1.69% | S&P: -0.81%

Catch Up Quick

• Texas lifts all coronavirus restrictions including its mask mandate, allowing businesses to reopen at 100% capacity

• All Apple stores in the U.S. open for the first time since the widespread business closures of early 2020

• Shares of Rocket Companies ($RKT), a highly shorted stock by institutional investors, jumped >70%

• Autonomous drone-maker Skydio raised $170M in Series D funding led by existing backer Andreessen Horowitz at a valuation >$1B

• U.S. manufacturing activity hit a 3-year high in February

• Instacart, a San Francisco-based grocery delivery company, raised $265M in new funding from existing investors → ~$39B valuation

• On Monday, the S&P 500 notched its best day since June 5th

• Goldman Sachs is slated to restart its cryptocurrency trading desk

• The U.S. is expected to impose fresh sanctions on Russia in wake of the poisoning of Kremlin critic Alexei Navalny

• The Chicago Board Options Exchange (“Cboe”) is seeking SEC approval to list a Bitcoin ETF according to a recent filing

• Jane Fraser is now officially the first female CEO of Citigroup

• Beijing is considering changes to Hong Kong’s electoral system that could remove pro-democracy politicians from local elections (CNBC)

• Shipments of J&J’s newly authorized vaccine are expected to reach states and vaccination sites as early as today

• Brazos, the largest power co-op in Texas, filed for bankruptcy

• The House passed a $1.9T coronavirus relief plan, including a $15 per hour federal minimum wage stipulation

Thought of the Day

• Last week, all 3 major U.S indices tumbled 3% — 5%, ending sharply in the red, as volatility has since trickled into this week

• Inversely, 10-year Treasury yields rose a hefty 48 basis points to nearly 1.62% from a low of 1.13% in mid February 

• While yields have since stabilized, currently sitting around 1.41%, last week’s market correction can be dissected via the relationship between Treasury yields and equity markets

• As the jump pushed Treasury yields temporarily above the dividend yield for the S&P 500, certain investors were incentivized to rotate out of stocks into bonds, to target a higher return than that of a dividend investing strategy, which also bears exposure to riskier equity markets

• Additionally, bond yields tend to follow Treasury yields, in which recent trends have increased the cost of debt, meaning companies looking to borrow money to fund operations or acquire other companies must pay a more in interest which hinders corporate investment

• From a mechanical perspective, higher treasury yields warrant lower stock market valuations

• Treasury yields are often referred to as the “risk free rate” or the highest rate of return an investor can expect with zero risk (i.e. zero standard deviation → fixed income payments from T-Bills are 100% predictable), driven by the idea that the U.S. government will never default on its debt

• With both multiples (EV / Sales, EV / EBITDA, etc) and DCF analyses, two of the most commonly used valuation techniques, the overarching idea is that the intrinsic value of a company (i.e. its stock) is the sum of its future cash flows discounted to present value via a discount rate representing a rate of return achievable with other investments (an opportunity cost)

• Rising yields increases said discount rate (quantitively → via the capital asset pricing model in the cost of equity of WACC, qualitately → other investments such as bonds become more attractive compared to stocks), which lowers enterprise valuations and in turn equity valuations (stock prices)

• This concept is more clearly visible by the inverse mathematical relationship between present values and discount rates, as shown below:

The Bottom Line

• The reasons behind why rising Treasury yields tend to induce lower stock prices get complicated quickly, though the key takeaway is that understanding this general relationship and monitoring T-Bill activity is a useful tool for stock market investors of any experience level!

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