Since the global pandemic stock market investors have been bombarded with market commentary of persistently high inflation, resulting high interest rates, and a so called yield curve inversion that’s likely to bring economic recession. And with the incoming administration’s threat of trade tariffs inflation expectations are well, re-emerging. Let’s break these relatively complex topics into their simpler components via chart analysis and present what I think is a constructive takeaway for the stock market in 2025, particularly for growth-oriented stocks. The Fed will adjust the Fed Funds policy rate based on their dual mandate of maximum employment and price stability. The jobs market has been quite strong, or as they say ‘tight’, with very low unemployment. With many workers gainfully employed that means worker’s compensation is being spent in the economy potentially driving inflation. To start let’s talk about the short-end of the yield curve, 2-year yields and shorter in maturity. The first chart we’ll look at is the 2-year inflation expectation as produced by the St Louis Fed FRED database in dark blue. Overlaid on that is the US 2-year Treasury yield in red. As inflation expectations go up, investors are less likely to want to hold bonds so they sell bonds and the yields go up. Therefore yields and inflation expectations are mostly positively correlated. Though not shown, the Fed’s short-term policy rate is largely driven by the 2-year US yield, hence the Fed’s policy rate is highly influenced by inflation expectations. Now let’s bring in the long-end of the curve with an overlay of the 10-year US yield in blue. You’ll notice that in the last 3 months the 10-year yield has made a noticeable move higher towards 4.8% while the 2-year yield has remained stable around 4.40%. Why is the 10-year yield moving higher at a faster rate than the 2-year yield? This could be attributable to several reasons that are beyond the scope of this article, but it’s creating a constructive dynamic. Let’s break down the respective technicals of the 2-year yield and the 10-year yield. On the left the 2-year yield has a Fibonacci retracement resistance level just above at 4.46%. Current Fed Funds rates are 4.25% to 4.50%. Examining the CME’s Fedwatch Tool you see the next time a rate cut is expected is not until July 30th. So the 2-year yield is expected to hold this resistance level as the Fed is not likely to cute rates in H1 of ’25. Turning to the right side of the 10-year yield chart, we have a bit higher to move before resistance is found from the Oct ’23 high of 4.98%. Pulling this altogether if we subtract the 10-year yield from the 2-year yield we get the often referred to yield curve in black. Looking at the yield curve around the horizontal highlighted line, this is the zero level, or threshold of an inverted yield curve and a normal yield curve. If the yield curve is below the yellow line the economy is viewed to be weakening and a recession is expected. If the yield curve is above the zero divide the economy is viewed to be recovering and in a constructive position. Overlaid on that is the S & P 500 and since the COVID 2020 lows one could make the argument that the S & P 500 is following the direction of the yield curve; higher in this case. Furthering this analysis let’s replace the S & P 500 with the growth stock/value stock ratio ( VUG / VTV ) ratio. You can also see that as the yield curve normalizes (heads higher), growth stocks have been outperforming value stocks. The top 5 growth stocks in VUG are AAPL, NVDA, MSFT, AMZN, and META. That’s the kind of stuff bull markets are made of. Going forward keep an eye on the upside resistance levels I provided in the 10 and 2-year yields. (Monitor the yield curve here. ) Having an understanding of how short-term bond yields interact with long-term bond yields will make you a better investor and make sense of our new higher rate, higher inflation environment. -Todd Gordon, Founder of Inside Edge Capital, LLC Disclosures: Gordon does not own VUG or VTV, but owns AAPL, NVDA, MSFT, AMZN, and META All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
Why stock investors should stop worrying about the bond market
Jan 14, 2025
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