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Does the Sell-Off Imply Market Repositioning for Lower Growth?

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US equity market rout

The Dow Jones Industrial Average Index (DIA) tumbled more than 800 points yesterday as Treasury yields (TLT) (AGG) continued their upward march. The S&P 500 Index (SPY) and the tech-heavy NASDAQ Composite Index (QQQ) closed at falls of 3.3% and 4.1%, respectively, on the day.

Rising bond yields and signs of firming inflation have spooked investors. Investors worry that because the era of near-zero rates has ended, companies’ margins might get squeezed. Higher yields are usually negative for equities because companies’ borrowing costs increase as the risk-free rate increases.

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Higher rates and equities

Higher rates could also deter investments, which could impact companies’ earnings and stock prices. In the past few years, one of the factors fueling US equity markets has been cheap money. The end of easy money could put the brakes on the economy. The concern is echoed by a lot of market participants and experts. JPMorgan Chase’s (JPM) CEO, Jamie Dimon, mentioned in August that the unwinding of the Fed’s unprecedented quantitative program could backfire on the economy or even spark market panic.

Market panic is measured by the CBOE Volatility Index (VIX), which surged yesterday to its highest level since February. The declines in the markets were led by tech giants (XLK) such as Amazon (AMZN) and Netflix (NFLX). Tech stocks have been the major contributors of one of the largest US bull markets in history. Now, as the easy money policy is ending, investors could be making a shift to a more stable and defensive sector. Utilities, for example, fell just 0.5% yesterday. Rising bond yields also affected the US dollar (UUP) negatively, which created safe-haven bids for gold (GLD). Gold prices were up 0.25% yesterday.

You can read Why Gold’s Upside Potential Seems to Outweigh Downside Risks for more on gold’s outlook amid the current macroeconomic environment.

Upcoming earnings season

Whether or not this initial market reaction to rising yields and inflation (TIP) will last depends on companies’ upcoming earnings reports and, more importantly, their outlooks for the fourth quarter and for 2019.

Before we discuss this topic in more detail, let’s discuss the tech sector’s rout and see if it seems like a long-term rotation in light of companies’ stretched valuations.

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