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The speed of the yield jump is unnerving for stock bulls. Bond yields are rising much faster than profit growth. The broad market has run into trouble whenever the growth in yields has surpassed the growth in earnings. More serious equity pullbacks have occurred when this differential is negative 10% or lower, as is currently the case. This scenario has historically been associated with too rapid an increase in inflation expectations, which spells valuation and monetary trouble ahead. The current signal from this indicator is negative, as the differential is at its widest level in more than 20 years.
However, it should be noted that inflation expectations are not problematic at the moment, and the very low starting point in yields reduces the indicator’s efficacy. Still, this gauge has a reliable track record, underscoring that capital preservation should remain of paramount concern.
Bottom Line: Our U.S. Equity Strategy team is retaining a tactically cautious view of the broad market, and continues to refrain from putting new cash to work.
This post was originally published by the BCA Research blog.