The year 2020 will be remembered for the coronavirus pandemic, global recession, and a record stock market run. Despite global economic upheaval, stocks rallied with all of the major indexes, the S&P 500, Nasdaq, Dow Jones Industrial Average, and Toronto Stock Exchange hitting record levels.
The unprecedented run has led to stocks being overvalued. Since the stock market is cyclical, we know a stock market correction is coming.
Are We on the Verge of a Stock Market Correction?
Stock market corrections don’t just happen, there needs to be bearish indicators to stop the bull. Rising bond yields are that brick wall. Global stocks have been in the red for the past week, with rising bond yields causing investors to question whether nosebleed valuations can be sustained, especially tech stocks.
Yields on the 10-year Treasury continue to edge higher. As of this writing, the 10-year Treasury is near 1.4%, still near record lows, but up significantly from 1.1% in early February.
What’s the big deal about bond yields? Ultra-low bond yields have been fueling the boom in equities and tech stocks, in particular. With yields so low, there’s no where else for investors looking for gains to turn but the stock market. And investors looking for outsized gains have turned to fast-growing tech stocks.
But that comes with inherent risks.
Higher bond yields, which move inversely to price, erode the value of future cash flows, more so for growth companies than mature blue-chip (value) stocks. That’s because tech stocks are still in the early days of growth and expect to see a bigger share of their profits come further down the road. As a result, smaller, less profitable growth stocks, are most sensitive to rate hikes.
And we’re witnesses to that right now. The tech-heavy Nasdaq is down nearly 10% from its recent high, a move which is usually used to define a stock market correction. On the morning of Thursday, March 4, the Nasdaq was down 9.8% at 12,782.35 after hitting a February 16 peak of 14,175.11.
Could the Nasdaq fall into correction territory? Again, bond yields are near 1.4%, but history suggests that a yield of 1.75% on the 10-year Treasury is the tipping point where investors begin to shift their assets back to bonds.
Time will tell; we’re still in the early days of what could turn into a full-blow stock market correction.
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