Morgan Stanley says bond yields and tech stocks reflect “extreme anomalies” of the dotcom boomرة

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The relationship between high-flying tech stocks and US Treasury yields has broken down, echoing “the extreme skews of the dot-com boom when tech valuations went unconstrained,” according to Morgan Stanley.

“For most of the past 20 years, tech stocks have traded squarely with economic growth—carrying a positive correlation with long-term Treasury yields—as investors have viewed them as correlated with positive economic growth,” said Lisa Chalet, Morgan Stanley’s chief investment officer. This week’s report. “Abundant liquidity” is now distorting interest rates and tech stocks, which are now negatively correlated at their lowest level since 2000, when the market experienced an online stock bubble.

This chart in a Morgan Stanley report shows the relationship between the S&P 500 IT index and 10-year US Treasury yields since 1990.

“With technology trading at a 60% premium in an already expensive market, interest rate sensitivity is again negative, suggesting that any support in yields will be strong headwinds,” Shalit said in the report. “The concentration of the index in technical stocks increases market fragility.”

Major US stock indexes – the S&P 500 SPX, -1.00%, the Dow Jones Industrial Average DJIA, -1.01% and the Nasdaq Composite COMP, -0.79% – have risen this year to a string of new records. FactSet data shows that information technology is the largest sector in the S&P 500.

“The second quarter ended with growth-dominated US stock indices at all-time highs and up more than 14% for the year so far, while value and cyclical stocks slumped despite expectations of about 10% nominal GDP growth this year,” Shalit said. in the report. “This dynamic can be explained by the 30 basis point decline in the 10-year US Treasury yield and the hawkish bias by the Federal Reserve.”

The 10-year Treasury yield, TMUBMUSD10Y, fell 1.293% by about 30 basis points during the second quarter, and slipped further in July to trade around 1.3% on Thursday afternoon. This compares to a return of over 1.7% at the end of March. Lower Treasury yields have benefited from long-term, rate-conscious growth stocks, as investors in recent weeks have been rotating them from value and cycle bets.

Read: What’s next for the stock market’s “big turn” as the “growth versus value” battle looks for direction?

“The drop in 10-year Treasury bond prices is simply boosting long-term assets,” Shalit said. “But is just about everything now a long-term asset?”

Stocks that typically account for 20% to 25% of the S&P 500’s market capitalization are considered “bond proxies,” because they rise when returns fall and vice versa, according to the report, which cited data from empirical research partners. Today, stocks classified as “bond agents” have surged to more than 35% of the index’s market capitalization, “and these stocks are disproportionately found among the tech giant’s killers.”

This could put portfolio diversification at risk.

“Shares of the tech giants have been acting like bond agents not only undermining portfolio diversification efforts, but increasing the vulnerability of the stock market to higher prices,” Shalit said in the note. “Tech stocks are only priced to get about 130 basis points more than 10-year Treasuries.”

Meanwhile, the US stock market was trading broadly lower on Thursday, with all three major indexes down nearly 1%.

See: Dow drops nearly 400 points as bond yields continue to slide

“In a market filled with liquidity, zero floor on the federal funds rate, extreme stock valuations, above-average duration bond indices, and corporate credit spreads in historically tight periods, interest rate sensitivity has rarely been greater,” Shalit warns in his book. Report.

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