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Bond Yields On The Spectrum: From Good To Ugly
Is the bond selloff the Revenge of the Bond Vigilantes, i.e., a looming debt crisis? Not yet. Despite the recent surge, the 10-year Treasury yield remains below the growth rate of nominal GDP. That points toward an upward repricing of the neutral interest rate. Ed and Elias examine the spectrum of forces behind higher yields, from rising R* to a potential debt-crisis scenario. The real warning sign would be if the yield rises above nominal GDP growth. In addition, they consider two other spectrum scenarios: the war in the Middle East and the yen-carry trade. … Also: The latest labor market data suggest resilient but noninflationary strength. … And: Dr Ed reviews “Tony” (+).
US SECTORS CALL: Information Technology, Consumer Discretionary & Consumer Staples
The S&P 500 fell 0.3% last week. Energy (OW) and Information Technology (MW) led the week’s sector performance derby, both up 1.4%. Utilities (MW) was the only other gainer, up 0.7%. Health Care (OW) was the weakest at -2.7%, followed by Financials (OW) at -2.5%. On a ytd basis, Energy is up 40.4%, the best of the 11 sectors, and IT is second at 30.2% (chart). We lowered our rating on Utilities last week from overweight to market weight. We argued that the sector's valuation discount rewarded investors for waiting out the bond market. The 10-year Treasury yield has since risen to 5.28%, after peaking at 5.34% earlier this week. We don't expect the sector's multiple to recover until yields stop climbing. Here's more on Information Technology, Consumer Discretionary, and Consumer Staples: (1) Information Technology. Micron is now the third-largest company in the S&P 500 Semiconductors industry. Its market value of $1.21 trillion trails only those of Nvidia and Broadcom and leads AMD at $1.03 trillion. Micron's stock price is up 276.6% ytd, ahead of AMD at 196.0%, Nvidia at 25.4%, and Broadcom at 2.6% (chart). Its forward revenues are $271.3 billion, and its forward profit margin is 73.1%. It trades at just 6.3 times forward earnings. The memory shortage is a capacity problem, and capacity requires equipment. Semiconductor Equipment was the best-performing IT industry this week, up 10.6%; it’s up 97.3% ytd. Analysts expect the industry's earnings to grow 35.1% this year and 48.6% next year, on revenue growth of 22.4% and 36.7% (charts). Its forward P/E is 31.1, down from 52.3 on June 30. Information Technology's share of the S&P 500's market cap rose to a record 39.3%, above the 2000 peak of 32.9% (chart). The difference this time is earnings. IT accounts for 36.3% of the index's forward earnings, a gap of just 3.0 percentage points. At the 2000 peak, the gap was 17.5 points. Investors are paying for earnings they can see. We retain our market weight rating on Information Technology. (2) Consumer Discretionary. Consumer Discretionary slipped 0.2% this week and is down 5.1% ytd, the second worst of the 11 sectors after Utilities. Its earnings look better than its stock price, but only because of one company, Amazon. Analysts expect Amazon’s earnings to grow 79.4% and the Consumer Discretionary sector’s earnings to grow 36.1% this year (chart). Much of Amazon's expected growth represents a one-time gain. Its 2026 earnings include mark-to-market gains on its Anthropic stake. Outside Broadline Retail, only the expected growth of Automobile Manufacturers tops 30%. Homebuilding is the weakest link. Analysts expect the industry's earnings to fall 16.1% this year after a 26.6% drop in 2025. Forward earnings has fallen to $190.46 per share from $292.11 last year (chart). The index trades 3.3% below its 200-day moving average. We retain our underweight rating on Consumer Discretionary. (3) Consumer Staples. Investors de-rated the market this year. They didn't de-rate Staples. The S&P 500's forward P/E has fallen to 19.3 from 22.2 at the end of 2025. Consumer Staples’ forward P/E is at 20.7, barely changed from 20.8 at year-end 2025 (chart). Earnings don't justify the premium. Analysts have cut their consensus 2026 earnings estimate for the sector to $41.30 per share from a 2024 peak of $46 (chart). Their 2027 estimate has fallen as well. The sector's forward profit margin of 7.1% is the lowest of the 11 sectors’. The retailers are the most expensive part of the sector. Consumer Staples Merchandise Retail trades at 31.0 times forward earnings. Analysts recently raised the industry's 2026 earnings growth forecast to 16.0% but cut the 2027 forecast to 6.9% (chart). Consumer Staples has the lowest consensus long-term earnings growth of the 11 sectors at 8.7%, against 27.3% for the S&P 500. Its share of the index's market cap has fallen to 4.4%, the lowest since at least 1995, with an earnings share of just 4.0% (chart). We are retaining our underweight rating on Consumer Staples.
GLOBAL MARKET CALL: Bond Vigilantes Gone Wild
The Bond Vigilantes have gone wild worldwide, pushing government bond yields higher in developed and emerging markets alike. A month ago, we asked whether rising yields reflected stronger growth, higher inflation, or looming fiscal crises. We still think the answer is mostly growth. The exception is where government finances are weakest. There, bond investors are charging a fiscal-risk premium. France may be on the verge of a full-blown debt crisis. Here's more: I. Global Bond Yields US Treasury yields rose on Friday even though September payrolls increased only 29,000. The 10-year US Treasury yield ended the week at 5.28%, after hitting its highest level since 2002 midweek (chart). Higher real yields account for nearly all of this year's increase, while inflation expectations have barely budged. In the UK and Australia, 10-year yields are higher still, at 5.37% and 5.36%. Japan's is 3.09% and still climbing. The French government now pays more than Italy or Greece to borrow for 10 years (chart). The yield spread between the French and the German 10-year government bonds jumped on Thursday, when France unveiled a 2027 budget that freezes public-sector pay and most pensions to limit the budget deficit to 5% of GDP. The spread is now the widest since the Eurozone debt crisis of 2012. German yields fell last week as French yields rose. Inflation is running hot in both countries, so the gap reflects France's finances. Six of the 22 bond markets on our list have seen 10-year yields climb 100bps or more this year (chart). France leads at 131bps, with the US second at 112bps. Italy, Indonesia, Japan, and South Korea round out the group. Two-year government note yields are above central banks' official policy rates in all six economies on our chart, by as much as 107bps in the UK (chart). The gap is smallest in Australia, at 34bps. The Reserve Bank of Australia raised its cash rate by 25bps to 4.60% on September 29, its fourth hike this year. II. Global Stocks South Korea's ETF has nearly doubled this year, up 97.4% in dollars, with Taiwan's up 83.1% (chart). The Emerging Markets ex-China ETF (EMXC) is up 39.4%, and its lead over the broader Emerging Markets ETF (EEM) widened to 15.7 percentage points last week from 14.9. We continue to prefer EMXC over EEM. France's ETF is down 6.1%, the weakest developed market on our list. The US ETF (SPY) is up 12.9%, in the top half of the rankings. Stay Home vs Go Global match has been in a stalemate in recent months. The US ETF trails the All Country World ex-US ETF (ACWX) by only 0.3 points ytd, versus 1.0 a week earlier. The MSCI USA ETF (PBUS) and ACWX have moved in lockstep, and both pulled back from record highs last week (chart). III. Currencies The dollar has rebounded off the bottom of its long-term uptrend channel. The US Dollar Index (DXY) is at 101.9, up from 99.2 at the start of September (chart). We have expected the dollar to stay firm, and it has. The euro's slide accounts for much of the dollar's gain, since the euro carries a 57.6% weight in the DXY. The euro is trading at $1.13, its lowest since May 2025 (chart). It fell sharply on Thursday, alongside French bonds. The yen is trading at 157.68 per dollar, near the middle of its 153-160 range since the joint US-Japan intervention in late July (chart). Japan's latest data show no intervention since late August. IV. Weekly Focus (1) Seaborne crude oil shipments exiting the Gulf have rebounded to roughly 16.5-17.5 million barrels per day (averaging around 98% of pre-war levels, excluding Iran). Major producers like Saudi Arabia have driven much of this rebound. While crude flows have recovered, refined fuels like diesel face severe ongoing bottlenecks. Refined product flows remain a fraction of pre-war norms (hovering well below historical averages), keeping global diesel supplies and pricing tight. On Friday, the G7 announced the coordinated release of up to 100 million barrels of emergency oil and diesel inventories. (2) Inflation data across Europe underscored lingering stickiness, with annual prints registering at 3.3% in Germany, 3.0% in France, 4.1% in Italy, and 4.9% in Spain. (3) In Asia, a hotter-than-expected Tokyo-area inflation report reinforced expectations of further policy normalization by the Bank of Japan (BOJ). Tokyo’s core CPI (excluding fresh food) jumped to 2.7% y/y in September, accelerating sharply from 1.8% in August and pushing inflation back above the BOJ’s 2.0% target for the first time in several months (chart). The core-core measure climbed even higher, to 3.0% (up from 2.0% in August). Services inflation also rose notably, to 2.3%.
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