Morning Notes — Bond Yields and Rotation

Higher bond yields shouldn’t become a problem for value sectors in the near-term.  Ten-year Treasury yields above ~1.16% would likely be a catalyst for further value outperformance. But if US inflation break-even yields are any indication of future nominal yields, you should be prepared to see rotation out of expensive growth stocks. This would represent a change to our forecast.  Importantly, value sector outperformance probably requires an up-market environment, so the re-rating of expensive multiples would need to be gradual.  Still using 10-year yields as our guide, at this point we’d expect some broad equity weakness above ~1.39%.  In the meantime, we look to add value stocks (regional banks, insurance, mining, construction and retail) as long as the 5-year/30-year Treasury yield spread stays above ~130bps and 10-year rates stay below ~1.39%.  The value/reflation theme is now more popular than it was when we introduced it in mid-September.  All sectors, including value sectors are currently short-term overbought.