The stock market experienced a volatile session on Wednesday, as investors weighed the implications of rising bond yields and oil prices on the global economy. The S&P 500 ended the day slightly higher, while the Nasdaq Composite and the Dow Jones Industrial Average closed in the red.
Bond yields hit highest level since 2007
One of the main drivers of the market turbulence was the surge in the 10-year Treasury yield, which climbed above 4.6% for the first time since 2007. The yield, which moves inversely to the price of the bond, reflects the market’s expectations of future inflation and interest rates.
The rise in bond yields was fueled by several factors, including the Federal Reserve’s signal last week that it will likely start tapering its bond-buying program in November and raise interest rates in 2024, sooner than previously anticipated. The Fed’s hawkish stance was prompted by the persistent inflation pressures in the US economy, which have been exacerbated by supply chain disruptions, labor shortages, and rising energy costs.
Some analysts and investors also pointed to the possibility of a US government shutdown and a debt ceiling crisis, which could further strain the fiscal situation and erode the confidence in the US dollar. The US Congress has until September 30 to pass a spending bill to keep the government running, and until mid-October to raise the debt limit to avoid a default.
The higher bond yields have a mixed impact on the stock market, depending on the sector and the valuation of the companies. Generally, higher yields make bonds more attractive relative to stocks, especially for risk-averse investors. Higher yields also increase the borrowing costs for businesses and consumers, which could dampen the economic growth and corporate earnings.
However, some sectors, such as financials and energy, could benefit from higher yields, as they indicate a stronger economic outlook and higher profit margins. Moreover, some investors view the rise in yields as a healthy correction, as they reflect the normalization of the monetary policy and the recovery from the pandemic-induced recession.
Oil prices reach one-year high amid supply crunch
Another factor that roiled the markets was the spike in oil prices, which reached their highest level in a year. The West Texas Intermediate, the US benchmark, traded above $94 a barrel on Wednesday, while the Brent crude, the global benchmark, hovered around $100 a barrel.
The rally in oil prices was driven by the tight supply situation in the global oil market, which has been affected by the production cuts by the Organization of the Petroleum Exporting Countries and its allies (OPEC+), the hurricane-induced disruptions in the US Gulf Coast, and the low inventory levels at the Cushing storage hub in Oklahoma.
The demand for oil, on the other hand, has been recovering steadily, as the vaccination campaigns and the easing of lockdown restrictions have boosted the mobility and the economic activity in many parts of the world. The International Energy Agency (IEA) recently raised its forecast for the global oil demand growth in 2023, citing the strong rebound in China, India, and the US.
The surge in oil prices has a significant impact on the inflation outlook, as energy costs account for a large share of the consumer price index and the producer price index. Higher oil prices also affect the profitability of various industries, such as transportation, manufacturing, and retail, which rely heavily on fuel and electricity.
However, some analysts and investors argue that the rise in oil prices is temporary, as the supply and demand dynamics will eventually balance out. They expect that the OPEC+ will increase its output in the coming months, as the group has agreed to gradually restore its production by 2 million barrels per day by the end of the year. They also anticipate that the US shale producers will ramp up their drilling activity, as the higher prices make their operations more profitable.
Market outlook and strategies
The market volatility is likely to continue in the near term, as investors monitor the developments in the bond and oil markets, as well as the political and pandemic-related risks. The market sentiment could also be influenced by the upcoming earnings season, which will kick off in October, and the economic data releases, such as the jobs report, the consumer confidence index, and the gross domestic product (GDP) growth.
Some experts and investors suggest that the market conditions favor a diversified and balanced portfolio, which can withstand the fluctuations and capture the opportunities in different sectors and regions. They recommend investing in high-quality companies with strong fundamentals, resilient cash flows, and reasonable valuations, as well as in sectors that can benefit from the economic reopening, the infrastructure spending, and the green transition.
They also advise to hedge against the inflation and currency risks, by allocating some funds to assets that can preserve their value and generate income, such as commodities, real estate, and dividend stocks. They also advocate for a global perspective, by exploring the emerging and frontier markets, which offer higher growth potential and lower correlation with the US market.