Stocks were challenged Monday after comments from a Chinese regulator insinuated he sees the stock market as overvalued. The remarks overshadowed another slip in rates, which typically lifts stocks.
Dow Jones Industrial Average
fell 143.99 points, or 0.46%, to close at 31,391.52 points. The
fell 31.53 points, or 0.81%, to end at 3,870.29, and the
fell 230.04 points, or 1.7%, to close at 13,358.79. The biggest gainer in the Dow was chemical giant
(ticker: DOW), which saw shares surge 1.9% on an upgrade.
Guo Shuqing, head of the China Banking and Insurance Regulatory Commission, said at a press conference, “Financial markets are trading at high levels in Europe, the U.S., and other developed countries, which runs counter to the real economy.”
Those words from China’s chief banking regulator spooked stock investors, not because Shuqing necessarily has more information or insight than investment decision-makers have, but because stocks are indeed trading at lofty levels.
Investors might now think twice about current exposure levels to stocks. First off, valuations are stretched. The equity risk premium for the S&P 500, or the excess rate of return investors demand for being in the average stock in the index over and above the yield on safe bonds, is at roughly 3.15%. The lower the premium, the less attractive stocks are, and the risk premium has rarely dipped below 3% in the past decade or so, according to research from Morgan Stanley strategists.
“It does seem like the China talks got risk assets off on a bad foot today,” Tom Graff, head of fixed income at Brown Advisory, told Barron’s.
Interest rates have recently calmed, a welcome development for stock investors. After touching 1.55% last week—up drastically from mid February—the 10-year Treasury yield has fallen back, dropping Tuesday to 1.41%. Higher rates indicate firming inflation and demand expectations—sure—but the recent disorderly spike in rates was taking too large a bite out of the present value of future corporate profits for stock investors to ignore. With the move up in rates subsiding in the past several trading days, stocks have resumed rising, with the S&P 500 up 2.2% since early Friday morning, which marked the index’s low point for the past one month.
Lower rates disproportionately benefit growth stocks, but it was that group stocks leading the market down on the day. The
Vanguard S&P 500 Growth ETF
(VOOG) fell 1.3%, with its value counterpart down just 0.2%. “I’m not sure [the selloff is] directly rates-related,” Graff said. “China may be moving [stocks] today, but rates are the important thing to watch.”
The Chinese regulator’s comments heightened already-lingering fears, and investors are acutely aware that stocks are getting more expensive against bonds. More positive developments are needed to move equities significantly higher in the near term.
Write to Jacob Sonenshine at email@example.com