BCA Research thinks something needs to break in the stock market in order to bring an end to the bond sell-off.
The research firm pointed to how bond yields have been surging, with a historic sell-off in the US Treasury market fueled by investors’ inflation anxieties. Barring a resolution in the Middle East, the sell-off is unlikely to stop until US stocks see a “meaningful” drop, the firm wrote in a note to clients on Wednesday, adding that the risk-reward for global stocks looked “poor.”
“US stocks and bonds are on a collision course,” Arthur Budaghyan, a strategist at the firm, said.
“Global share prices and bond yields are unlikely to rise simultaneously for much longer. A further rise in yields will produce a drop in the stock market. A meaningful tumble in share prices will eventually lead to a decline in bond yields,” he later added.
Stock market internals look “very weak at the moment,” Budaghyan said. He pointed to the narrow breadth of the latest stock rally, with most of the gains being concentrated in the AI and semiconductor sectors amid the fresh burst of bullish sentiment in the second quarter.
Technology stocks in the S&P 500 are up 23% for the year, far outpacing the broader index’s 8% gain. Meanwhile, the iShares Semiconductor ETF continues on a historic rally, having climbed 65% year-to-date.
But worries about inflation have prevented the broader market from moving higher. Investors have been preoccupied with higher oil prices since the start of the Iran war, with concerns building that inflationary pressures will soon spread to other goods and crimp economic growth.
Inflation accelerated to a 3.8% yearly pace in April, the fastest consumer prices have grown in three years.
Wall Street has been largely optimistic that the latest inflation surge will be short-lived. But a resolution regarding the Strait of Hormuz, which has been closed since the start of the war, is unlikely to be “imminent,” BCA Research said, speculating the conflict could “get worse before it gets better.”
Higher bond yields have also historically been a negative for stocks and other risk assets, as they suggest rates in the economy will stay higher for longer.
“A meaningful equity selloff may be needed to generate enough disinflationary pressure to offset the inflation impulse from oil and food,” Budaghyan said.
“Our hunch is as follows: As long as the market perceives the Fed as having fallen behind the curve, then rising bond yields will be negative for share prices,” he added. “In the current situation, only a material drop in US equities could bring down US bond yields considerably.”
Though the indexes remain close to record-highs, the outlook for markets soured in recent weeks as investors eye the threat of inflation and higher rates.
In a note to clients last week, Morgan Stanley pointed to the spike in bond yields and said stocks could soon enter a “meaningful correction.”
Goldman Sachs said higher bond yields and intensifying the concerns about inflation were raising the risk of a market correction, though the impact on stocks depended on how quickly yields continued to climb.
