Cheaper US stocks catching up expensive peers on Wall Street, thanks to rising bond yields

US bond yields rose to as high as 1.61% last week — highest in the last 365 days, as inflation concerns surface with a recovering global economy. Along with this jump in bond yields, cheaper, less popular parts of the market are now outperforming those that have bettered even the benchmarks, according to Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. This trend in the market might help revive the old ‘buy low, sell high’ strategy, something that has been missing for a while, Sheets said in a podcast.

Buying low, selling high

The ‘buy low and sell high’ strategy has not worked over the last five years, Sheets said. “The best performing strategies were often those that focused on momentum, buying assets that were already going up and selling assets that were already going down,” the market strategist added. Till the middle of February, if an investor had bought stocks that had outperformed the S&P 500 by over 44% in the last five years, the ‘buying high’ strategy would have worked.

Meanwhile, ‘buy low’ strategy was challenging. “There are many, many ways to define value in the stock market. But if we use the definitions in the Russell Indices, the more expensive half of the US market has outperformed the cheaper half of the market by about 110% over the same five-year period,” Sheets said. This was also aided by technology companies that made up the expensive half of the market and continued to soar higher.

Low bond yields, abnormal markets

So far, investors continued to push expensive stocks higher as bond yields were low. “The more abnormal the economic environment, the easier it is for the market to pay a higher valuation for better, more exciting businesses,” Andrew Sheets highlighted. Investors are lured towards safer and better-placed companies in times that were witnessed last year. Equities by nature are risky assets.

Reversing the trend

With the global economy now recovering from the pandemic and economic outlook improving, bond yields are coming back up. Investors keen on diversifying their portfolios are likely to move back to bonds that offer a higher return than a year ago. This trend is now aiding the recovery of stocks that were cheaper. “In the last two weeks, the more expensive half of the US market is down about 5%, while that cheaper half is up about 1%. This extends globally. European stocks, an inexpensive market that has also lagged its global peers badly over the last five years, is higher over that same two week period,” Sheets said.