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In another week dominated by economic headlines, 90% of my focus continues to be centered on yields and how new economic data is impacting yields. Financial markets continue to suffer in an environment of rising yields, for the simple reason that yields and asset prices are inversely correlated, all else being equal. My favorite way to illustrate this relationship is to compare the Ark Innovation ETF $ARKK (candles) and the inverted 10-year Treasury yield (teal):
As yields rise, shown by a decrease in the teal line, the price of $ARKK also declines. These two variables move in near-perfect lockstep. There will be brief periods where this correlation deviates from the normal dynamic; however, the standard correlation eventually resumes: Yields ↑ Asset Prices ↓
We see this relationship perfectly in the chart above, showing how higher yields cause the present value of an asset to decrease.
Understanding this relationship is what caused me to be bearish on $ARKK in November 2021, explaining that the path of least resistance was for yields to rise. Since I published that outlook in Edition #127 , $ARKK has fallen -62.5%.
After a brief cooldown period, where 5, 10, and 30-year Treasury yields started to decline, we’ve seen yields extend higher rapidly over the past two weeks. Yields gained extra momentum on Friday following the May 2022 CPI release, in which inflation was higher than expectations. Let’s compare the weekly increase in yields vs. the weekly performance of the U.S. stock indexes:
5-year Treasury Yields $FVX: +10.1%
10-year Treasury Yields $TNX: +6.75%
30-year Treasury Yields $TYX: +2.6%
Dow Jones Industrial Average $DJX: -4.6%
S&P 500 $SPX: -5.1%
Nasdaq-100 $NDX: -5.7%
We continue to be in a market where yields have tailwinds to rise, caused by rising inflationary pressures and the Federal Reserve’s current policy to raise interest rates. There is no point in fighting this trend. The faster an investor has been able to accept these conditions, the better they have performed in the market.
In the remainder of this analysis, I’ll share important under-the-hood metrics for the S&P 500, analyze the performance of defensive sectors, share 16 stocks that I think investors should be watching, and attempt to contextualize this current drawdown in an important way. This market is extremely difficult and tumultuous, causing many investors to throw up their hands and essentially walk away from the market. However, this market environment is where the long-term, generational money is made. Instead of being discouraged, investors should be hyper-focused on the long-term opportunities that are currently available in the market. This will be the key theme of today’s newsletter.