Recently, all it seems investors can talk about is the relationship between the performance of growth stocks and interest rates. The general idea is that rising yields have a negative impact on the performance of growth stocks as the risk-free rate of return increases and future cashflows for high-growth companies are discounted at a higher rate.  To highlight this relationship, today we wanted to take a look at a comparison between the relative strength of the Vanguard Mid Cap Growth ETF (VOT) versus the Vanguard Value ETF (VOE) versus the yield on the 10-year US Treasury.

Looking first just at the relationship between the two this year, the chart below shows the relative strength of growth vs value (blue line) compared to moves in the 10-year US Treasury (red line).  When the blue line is rising, it indicates that growth stocks are outperforming value and vice versa. For pretty much the entire year, when yields have moved higher, growth stocks have underperformed, but when yields have pulled back, growth stocks start to lead the market.  Over the last several days, the inverse relationship has been even more pronounced where the two lines have completely moved in the opposite direction.  For this year at least, higher interest rates have been kryptonite for growth stocks.

The chart below is the same as above but goes all the way back to 2010 instead of just this year.  Looking at the chart, while there were periods of inverse correlation in the early and mid-2010s, the trend really didn’t fully take hold until late 2018/early 2019.  Since then, when rates have fallen, growth has outperformed and vice versa.

The inverse correlation has reached extreme levels this year.  The chart below shows the correlation coefficient between the daily ratio of the VOT (mid-cap growth) versus VOE (mid-cap value) versus the yield on the 10-year US Treasury.  Since 2010, there have been five years where the correlation coefficient was positive and in only three of those years was the positive reading anything more than negligible (2012, 2015, and 2018).  In each of the past three years, what we’ve seen is the inverse correlation only intensify.  Back in 2019, the only other year before that where the inverse correlation was more pronounced was in 2016, but then 2020 saw what was at the time the most inverse correlation since 2010.  Based on this year’s relationship, though, 2020’s record may not last long.  Through Tuesday’s close, the correlation coefficient between the relative strength of growth stocks and the 10-year yield was -0.87.  While the inverse relationship between growth stock performance and interest rates may not continue to be as pronounced as it is now in the future, any continued increase in long-term interest rates is likely to act as a headwind for the performance of growth stocks.  Click here to view Bespoke’s premium membership options.

The fifth and final manufacturing survey for the month of September from the regional Federal Reserve banks was released this morning, and it did not end the month on a high note.  The Richmond Fed’s headline reading fell into contractionary territory this month for the first time since May 2020 as the index dropped 12 points month over month falling from +9 down to -3.  Relative to all the other regional Fed reports, Richmond only Richmond reported contraction in September.

The 12 point decline month over month in the headline reading was significant ranking in the bottom 5th percentile of all monthly moves. But it was actually a smaller decline than last month when the index dropped 18 points.  Regardless, the 30-point combined decline over the past two months is the second largest on record behind the 38 point drop in April of last year.

Factoring into that headline weakness, most of the categories of the report were also lower month over month.  Given those declines, most readings are also now in the bottom end of their historical ranges with some exceptions.  Order Backlogs, Vendor Lead Times, Equipment and Software Expenditures, Employees, Wages, and price indices are all still in the upper decline of readings.

By far the largest decline in September was for New Orders.  That index plummeted 24 points versus August for the fourth-largest decline on record and putting the index in the bottom 5% of its historical range.  In other words, demand slammed on the brakes in September.  In spite of that decline, expectations have held up relatively well at 24; unchanged month over month. Shipments also fell into contraction albeit less dramatically.  Meanwhile, Vendor Lead Times improved as the index fell 2 points, but that remains an extremely elevated reading indicating continued pressures on supply chains.

One potential reason for shipments having pulled back is a complete lack of inventories.  Both readings on raw materials and finished good inventories fell month over month and are at historically depressed levels across both current conditions and expectations.

Indices tracking employment were perhaps the healthiest area of the report. The index tracking the Number of Employees edged higher to 20 while expectations saw an even larger jump, stopping just short of a record high. Wages, meanwhile, declined 9 points from a record high. That reading is still the third-highest on record, though, and expectations were at a record high. While the Average Workweek index was also lower MoM, there has been another improvement in the number of firms reporting a lack of availability of skilled workers.

The other area of the report to touch records this month concerned prices. Prices paid came in at a new high with prices increasing 14% annualized.  Prices Received were slightly lower at 9.13%, but that is well above other readings throughout the survey’s history and the expectations index set another record.  Click here to view Bespoke’s premium membership options.