How surging bond yields threaten to derail the momentum trade in stocks

It was a bit of a miracle the S&P 500 managed to deliver a weekly gain last week given the carnage in the bond market.

The Bloomberg Treasury: Long Index, which tracks the return of US government bonds with at least 10 years to maturity, slumped 2.6% for its worst week in more than a year. Renewed jitters about the duration of disruption to oil supplies, a big jump in US producer prices for April, and UK political hijinks (of all things) contributed to the bloodbath in bonds.

A couple factors that have contributed to softness in bonds over time, however, are much more positive for the stock market: US economic data has broadly surprised to the upside, and there’s immense demand for capital to funnel into data centers; both are pluses for the near-term earnings outlook.

But one thing that’s very different about this cycle compared to the totality of the past 32 years is how much the stock market loathes a spike in yields. (Bond prices move inversely to yields.) Since 2022, when long-term bonds are down at least 0.5% in a week, the S&P 500’s median return has been negative — deeply so for weeks when bonds are down at least 1.5%.

This is even more true for the tech-heavy Nasdaq 100:

And momentum, well, the most.

(It’s worth highlighting that the jump has taken bond yields to near the peak of their multiyear range. If the surge in 30-year Treasury yield peters out between 5% and 5.2%, you can’t say you weren’t warned: this would be the sixth time in the past three years that’s happened.)

Sharp changes in bond yields, in theory, suggest the broad economic backdrop may be different than we had anticipated. As such, that dynamic is a particular threat to the momentum trade.

“I don’t like change” is the momentum factor’s mantra. Think about it: momentum is betting that winners keep winning, and what could be a better backdrop for winners to keep winning than the world around them staying exactly the same?

“In general, Momentum as a factor performs best in periods of stasis,” wrote Goldman Sachs strategists led by Ben Snider.

To put a fine point on it: during last week’s bond rout, IGV outperformed SMH. That’s not something you would expect if you’ve been overly preoccupied with the idea that rising bond yields are an acute worry for software stocks, because of their long-duration cash flows. (Besides, hasn’t the real worry been AI tools crushing their ability to have long-term cash flows to begin with?)

In 2022, when rising yields undermined the stock market, momentum and software were highly correlated. Now, those two aren’t: momentum and semiconductors are swinging in tandem.

That same dynamic is holding true this morning: a backup in bond yields sent the VanEck Semiconductor ETF 2% lower as of 11:32 a.m. ET and the iShares MSCI USA Momentum Factor ETF underperforming while the iShares Expanded Tech Software ETF treads water in positive territory.