In consequence, the yield on US 10-year government benchmark bonds – arguably the world’s most important rate, which is why I don’t spend so many words on other rates here – rose by 48 basis points. That’s a lot in just one month.
It could have been worse, though. Could have been one year ago, when the 10-year benchmark yield rose by 66 bps.
For global bonds, as measured by the Bloomberg Global Aggregate index, falling by 2.9%, September was the worst month since, well, last September.
Both points serve as reminders of the accumulated increase in this interest rate cycle – the US Fed Funds rate has increased by a staggering 525 bps since March 2022. And commentators aplenty now echo the idea of “higher for longer”, meaning that interest rates won’t come down again as fast as we thought (or hoped).
This is supported by fixed income figures like forward rates or of course long market rates. The 10-year yield is still lower than the 2-year yield, but the size of the negative term spread has more than halved since June. This “surefire” recession indicator towers a little bit less, then, although for a reason few would have hoped to see. Lower short rates would have been much more comfortable.
Of course, we don’t know what rates the stock market expects to see in future. There is no forward stock market rate. We can, however, glean or infer something about stock market expectations from pricing differentials.
Yes, I’m talking about the pricing of value vs. growth stocks. As you would expect, growth stocks took a beating in September, falling by 5.1% (the MSCI World Growth index in local currency), more than twice the decline of value stocks. However, they did a lot worse in September 2022, falling by 9.2%. And they’re still up 22.1% year to date, vs. only 3.7% for the MSCI World Value Index.
In 2022, it was the other way around. The MSCI World Growth index fell by 27.3%, a full 24 percentage points more than its MSCI World Value sibling, reflecting an increase in the US 10-year benchmark yield of 2.37 percentage points. Growth stocks typically fall when higher interest rates make expected earnings further into the future less valuable in present value terms.
This makes their massive outperformance in 2023 all the more surprising.
How to explain the divergence? You’ll struggle to get past the idea that expectations of future rate cuts are stronger in the stock market than in the fixed income market. Otherwise, long-duration growth stocks wouldn’t be outperforming value stocks when interest rates keep rising. That’s pretty much what the textbooks imply and for once I can only concur. This year’s rate increase is decidedly more modest, but it’s still an increase.
Divergent expectations in the different securities markets are nothing new. Traditionally – as per prejudice, at least – stock investors are of a cheerier persuasion, whereas fixed income people are in the gloomier camp (or just more realistic). I take no bets on who’s got the clearest crystal ball.
But I know that such divergence is seldom solved by one side being 100% right.
Finn Øystein Bergh
Chief Economist & Strategist
Historical returns are no guarantee for future returns. Future returns will depend, inter alia, on, market developments, the portfolio manager’s skill, the fund’s risk profile, as well as fees for subscription, management and redemption. Returns may become negative as a result of negative price developments. This is marketing communication.