Can emerging markets stocks be used as an indicator for where bonds are going next?
With last week’s spike in bond yields, investors are left somewhat dumbfounded. On the one hand, higher interest rates are supposed to be bad for stocks. On the other hand, stocks had their highest-ever close. However, the stocks where US interest rates matter most aren't in the most obvious places.
Rates went up last week after the Federal Reserve's Open Market Committee's October meeting notes were released hinting that maybe – just maybe – they would consider tapering it $85 billion monthly bond-buying operations at some point in the near future. The markets are now anticipating higher rates down the road.
"Longer-term, they're going over 3% for 2014," predicts John Stephenson, portfolio manager at First Asset Investment Management. "In the short run, they're coming down."
While many in the market look at interest rate levels to determine what's next for the S&P 500 index, Steven Pytlar, Chief Equity Strategist at Prime Executions, says there's a bit more nuance to it.
"We have seen as it relates to the S&P and 10-Year yields, it’s the rate of change that matters, and not necessarily the trend in yields," says Pytlar.
"Since October, we've seen a steady rise in yields and the S&P has moved higher along with it," says Pytlar. "So, higher yields aren't necessarily a reason to jump out of the market. Where higher yields are a major headwind and are very closely correlated to lower prices is in emerging markets."
“There is a much closer [negative] correlation between US yields and the emerging markets than there really is between US yields and the S&P 500,” says Pytlar.
So, now the big question: Since emerging markets stocks and US interest rates have a very negative relationship these days, can emerging markets stocks be used as a secret indicator for where bonds are going next?
To find out the answer to this question – and to see why there’s a close relationship between US rates and emerging markets, watch the video above.
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