NASDAQ, which is a tech-heavy index, took hit on October 8th from its tech stocks when the investors pulled out their investment from the high-risk tech stocks. During the hours of trading, the index declined by 1.8% at maximum whiles the other index of Dow Jones and S&P 500 Index fell by 0.8%. All of the FAANG stocks also declined. These include the stocks for Facebook, Apple, Amazon, Netflix, and Google. The reason identified is the rising bond yield and the increasing interest rates, which are driving the investors away from the tech stocks (Wiener-Bronner, 2018).
As we have learned in our course, the bond yield is the amount of the return which the investor realizes on the bond. When the bond yield inclines, the opportunity cost of investing funds in other assets also increases. It means that the opportunity cost of investing in stocks also inclines. It consequently makes the stock investment less attractive. The opportunity cost is in actuality the cost of the next best alternative. It means that it is the difference in the returns offered by the bonds and by the equity stocks.
All stocks are considered riskier. It means that equity stocks need to have the risk premium over the bonds, which are the less risky assets. It shows that if the bond yield is X% and the risk premium the investors are seeking over the bond yield is z%, then the stocks are needed to offer X+z percent on equity to switch to equity. Thus, an increase in bond yields increases the opportunity cost of equity stocks (Mudgill, 2018).
The rising bond yields infer that the value of the bond is declining. It is the reason the increasing bond yields are not considered as desirable for the bond investors. Interest rates are one of the largest factors in the bond yield calculations, and rising interest rates are bullish for the stocks and for bond prices it tends to be more bearish. It shows that an increase in the seeking return to the investor can be witnessed for their money.
The Chief Investment Officer of the Advisor Alliance has also claimed a similar relationship. As per his statement, the rise in the rates is typically seen along with the tech stocks taking a hit. People tend to start getting concerned over the stock market and initiate pulling back their investment from risky stocks. He further explained the phenomenon by saying that investors usually consider these tech stocks as long-term investments and thus any rise in borrowing costs makes them see their returns to have moved further in time, making them switch to less-risky assets like consumer staples and utilities.
The benchmark for the bond yields; the 10-Year Treasury rose to its highest level in seven years to 3.24% influencing the borrowing costs, car loans, mortgages, and credit card rates. The intention of the Federal Reserve to constantly raise the target interest rate makes borrowing expensive. Whenever the Federal Reserve increases the target interest rate, all credit card holders and borrowers of auto loans, student loans, and mortgage holders see a significant difference in their interest rates. Credit cards, for example, use their rates on the bank prime rate, which is normally 3% higher than the Federal target interest rate. Furthermore, the cardholders also have to pay a premium on this prime rate as per their creditworthiness. All federal loans are tied to the rate of the 10-Year Treasury note which takes into account the Federal targeted interest rate and adjusted its loan rates every July (Hsu, 2017).
Summarizing, the rate of 10-Year Bond yield influences the borrowing costs, and the cost of paying back the current debt slows down the spending as well. It makes the investors try and lock in the profits that they have earned.
NASDAQ, being vulnerable to the bond yields and Federal Reserve target rates, gets affected by the changes as it has financial stocks which are influenced by the higher rate of interest. However, this does not imply that NASDAQ is expected to fall. In the recent past, the NASDAQ investors were seen to be overly optimistic about future growth as evident in the prices of the stock. It is only gaining back its actual normal position. The analysts have reasons to believe that market confidence will soon recover.
The article depicts the theoretical concept of bond yields, changing interest rates and changing bond prices. We have learned that the market price of the bond always changes over time, and it never remains the same. The article shows how the bond prices have declined to cause the bond yield to increase. It also shows how the market prices change over time as per the demand of the investors. The demand of the investors, on the other hand, depends on various factors.
For example, we had learned that the interest rates in the economy change over time, which affects the yields that investors demand. It has been seen in the article more clearly. The article showed how the rising bond yields have caused the tech stocks to decline. The article also showed how the changing interest rates are responsible for the changing bond yields. I specifically understand it more clearly by looking at it in detail and searching over the internet. I searched and found an article which explained how the rising interest rates affect the bond yields through increasing the borrowing costs of the investors and banks. Usually, the benchmark for the bond yields is the 10-Year Treasury bill, which has been seen as raised to its highest level influencing the borrowing costs, car loans, mortgages, and credit card rates as well. The Federal Reserve has constantly increased the target interest rate that eventually makes borrowing more expensive. Whenever the Federal Reserve increases the target interest rate, all credit card holders and borrowers of auto loans, student loans, and mortgage holders see a noteworthy difference in their interest rates.
The article showed the influence on credit card holders, mortgage holders, student loans, private student loans, and car loans. The credit card holders were shown to have the most significant influence on their interest rates as they use the bank prime rate, which is normally 3% higher than the Federal target interest rate. Furthermore, the cardholders also have to pay a premium on this prime rate as per their creditworthiness showing more increase in the credit card rate. All federal loans are tied to the rate of the 10-Year Treasury note which also takes into account the Federal targeted interest rate and adjusts its loan rates every July. The car loans and mortgage loans were found to have a less notable effect on their interest rates. However, the effect was similar. It showed me how the changes in interest rates influence the bond yields of the bond market.
The next phenomenon which I examined is the influence of the bond yields on the stock market. I don’t only see how the theoretical framework was implemented in real-world scenarios but also understood how these relationships work. For this, I also did not depend on this article only and searched for the relationship and found another good article which explained the relationship in detail. As per this article, when the bond yield inclines, the opportunity cost of purchasing another asset also increases. It makes the bond investment more attractive. Here I understood the fact that the bond and stock markets are competing with each other for the investor capital and the more attractive returns one pays, the higher opportunity cost it becomes for the other market. The opportunity cost is in actuality the cost of the next best alternative. If we assume that an investor is seeking a risk premium of 6% on the equity stock then, this means that equity stocks need to have the risk premium over the bonds which are the less risky assets. It shows that if the bond yield is 4% and the risk premium investors are seeking over the bond yield is 6%, then the stocks are needed to offer 10 percent on equity to leave the bond and purchase the equity stock. Thus, an increase in bond yields increases the opportunity cost of equity stocks making the stock less attractive.
The analysts claim that investors usually consider the tech stocks as riskier and also more of a long-term asset. It makes them fear the less attractiveness of the stock market by seeing their returns move further in time. However, I tend to disagree on this. If the investors consider the tech stocks as long-term assets, then they would not give in to these higher bond yields and would remain tied to the stocks for their long-term returns. I am putting this disagreement on my personal belief that if I am to invest in any stock in the long term, then I would not panic about small drops in the market and would consider giving it enough time to reap its benefits.
It shows that even with the application of the theoretical concepts which we have learned in our course in the real-world markets, much depends on the perception of the investors. This shows that the perception as derived by the different access to information forms the base for investor to either pull or push more investment. Depending on these perceptions, the analysis can differ as well. The article was good enough to illustrate the topics of changing bond prices, bond yields, and interest rates and their relationship with the stock market and Index declines. The support of the two other articles elaborated the concepts and helped in better understanding.
References
Hsu, T. (2017, December 13). How the Fed Rate Increase Affects Your Mortgage, Car Loan and Credit Card Bill. Retrieved from The New York Times: https://www.nytimes.com/2017/12/13/
business/fed-rate-mortgages-loans-credit.html
Mudgill, A. (2018, February 19). Why are rising bonds making stocks bleed from Wall Street to Dalal Street. Retrieved from Economic Times: https://economictimes.indiatimes.com/
markets/stocks/news/why-are-rising-bonds-making-stocks-bleed-from-wall-street-to-dalal-street/articleshow/62786726.cms
Wiener-Bronner, D. (2018, October 8). The Nasdaq is getting crushed. Here’s why. Retrieved from CNN: https://edition.cnn.com/2018/10/08/investing/
nasdaq-dip-explainer/index.html
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