Last week's surge in US Treasury yields triggered stock market turmoil, with one fund manager warning that investors were ill-prepared for the coming "pain".
Cole Smead, president of Smead Capital Management, said on Tuesday that investors need to weigh whether a company is affected positively by the economic recovery or by the negative impact on the "currency price" of the recovery.
"I don't think investors have taken into account the divergence between the economic recovery and the stock market decline," Smead said.
Yields on benchmark 10-year Treasuries rose sharply last week as economic growth and pent-up demand expectations boosted economic growth with the introduction of COVID-19 vaccine and pent-up demand expectations.As inflation expectations hit risky assets, investors began to consider the possibility that the central bank might tighten monetary policy.
The rise in yields eased late on Monday, with European 10-year bond yields at 1.4256 per cent on Tuesday, close to the level seen a year ago when the COVID-19 epidemic began to spread around the world.
But Smead said the 10-year Treasury yield exceeded 3% at the end of 2018, suggesting that momentum to return to the underlying economy could have a greater adverse impact on the stock market.
"I'm 37 years old, and most people in my age have never seen a bad bear market," he said. They were almost overwhelmed last spring, but they have never seen a really bad stock market, nor have they seen bonds lose money. "
"I don't think most investors are ready for this, because dogs chase cars, people chase stocks, that's just the nature of beasts," Smead said.
The recent rise in US bond yields has prompted investors to turn further to so-called cyclical stocks. Smead said that while "market risk looks scary, investing in risky assets looks great".
In recent weeks, most US blue-chip companies have released full-year results for 2020, mostly exceeding analysts' expectations. But Smead believes that market valuations are not affected by these fundamentals, and that if the economic recovery further drives up bond yields in the near term, the market could become vulnerable, and he believes that investors may see a lot of hellish pain over the next two to three years.