March 3, 2021
The preference for cyclical/value sectors is beginning to look more like a potentially painful rotation out of growth. High multiple stocks are now rerating lower. The extent of the rerating depends on the outlook for bond yields, because the Discounted Cash Flow (DCF) valuation model uses bond yields (risk-free rate) in the denominator. Simply put, higher bond yields get you a lower terminal value. Moving yields up or down 50bps will have a major impact on DCF-based valuations. Our forecast for higher yields is based on normalizing growth with some overshoot. We’re using a year-end target of ~1.70% for 10-year Treasury yields, but a near-term break above last Thursday’s closing high of ~1.51% would accelerate the rerating of high multiple stocks.