Stocks have successfully managed slowly rising interest rates over the past 18 months, but the recent pace of increases appears to have spooked investors. Demand for U.S. Treasuries was on the disappointing side this week, despite higher yields. The increased supply of Treasuries added pressure to an already sensitive bond market. Besides higher Treasury rates, yields on investment-grade and high yield bonds also widen for the first time since early 2016. Credit spreads are among the key variables we monitor closely as it relates to the health of the market and economy.
Despite this, we believe the sell-off in stocks will be contained. Corporate earnings and economic growth remain very strong. Inflation fears appear overdone. Most U.S. businesses and households are well positioned for higher rates in the coming year. Financial conditions in the U.S. and around the world remain supportive of higher prices. We are in the later stages of the business cycle, and higher volatility should be expected. The combination of the sell-off in stocks and upward revisions in earnings has improved valuation dramatically. As a result, we believe this recent pullback represents a buying opportunity. The cyclical rise in rates is reflective of strong global growth and a modest pickup in U.S. inflation expectation- both supportive of higher stock prices.
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