If you’ve been paying attention to the markets in last 25 months, you probably noticed that the U.S. 10-year Treasury yield has developed an inverse relationship with the Nasdaq Composite (pictured below). However, if I were to pull the chart back to 1996, you would see that the two of them had sustained a pretty direct relationship for almost 20 years.
To understand the significance of this, we need to first examine what the Nasdaq Composite really means. As opposed to the Nasdaq 100, the Nasdaq Composite is an index containing over 3000 of the world’s largest companies by market cap. Though it’s well diversified, the index is weighted by market-cap; so the 100 largest companies in the world (i.e. Apple, Google, Amazon, Microsoft, Tesla) drive about 90% of the action. In other words, the index is very much tech & growth weighted.
On the other hand, the U.S. 10-year Treasury has been viewed as the benchmark of investor confidence. Like all other bonds, when the yield goes up, it means the value of the bond is going down & vice versa. Additionally, because it’s a U.S. government bond, it’s also viewed as less risky; in some financial models (such as the WACC), it’s even used as the ‘risk-free rate’ to calculate risk premium.
Normally, when the yields on the 10-year rise, it means investor confidence is up. When investor confidence rises, investors no longer feel the need to play it safe and are encouraged to take on more risk for a higher return in the stock market. This rotation will then drive up both the Nasdaq and the 10-year yield.
But these are abnormal times. If the rising 10-year signals a pull back in the Nasdaq, it means investors are leaving the stock/bond market as a whole and going to cash (or maybe gold & crypto). This means investors are now rotating between cash & the stock/bond market, instead of rotating between the stock market and the bond market.
Why? Well, we currently have an almost $9 trillion Fed balance sheet that needs shrinking, 40% of all cash supply created after April 2020, inflation at 7.5%, and a central bank that can’t commit to a rate hiking plan. Unwinding these problems means reducing the monetary supply & velocity. Therefore, investors trying to time this monetary tightening have one focal point: Cash.
Cheers,
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