Morning Notes — Real Yields Test Important Levels

Over the past ~2 weeks, markets have been sending a signal that Omicron is the beginning of the end of Covid. We’ve seen this in rising nominal bond yields and equity markets with reopening themes outperforming.  Inflation breakeven yields rose yesterday, but lagged nominal yields and 10-year breakeven yields are down more than 4bps today.  The more subtle move in breakeven yields reflects expectations for a gradual improvement in supply chain bottleneck pressures.  The combination of higher nominal yields and slightly lower inflation expectations has taken 10-year real yields from -1.06 at year end to -0.94 today.  Once again, real yields and Tech multiples have a strong negative correlation.  Software multiples, particularly high multiple SaaS names are the most at risk. The average SaaS multiple has contracted from a record ~20x revenue in early-November to ~14x in late December.  There may be nothing fundamentally wrong with any of these businesses, but if real yields rise much further, you should expect more downside. In the near-term we’d expect another down leg for SaaS and relative underperformance from the Tech sector if 10-year real yields break up and through -0.92.  Should that occur, we’d expect the greatest downside for software companies with Operating Margins below ~20%.  The average SaaS stock traded at a record ~10x revenue pre-pandemic, which may provide an opportunity to add exposure through the highest quality, Rule of 40+ names.