The importance of Yields
Many investors were watching and worried about the sharp drop in Treasury yields when stocks fell hard on Monday. The 10-year yield, in particular, has been closely linked to the stock market, and when it continued to fall earlier in the week, reaching as low as 1.12 percent, stock investors became concerned.
The stock market rose when the yield reversed and began to rise on Tuesday.
Technical analysts are keeping an eye on the TLT, the iShares 20+ Treasury Bond ETF, for clues about yields. They believe the ETF’s performance may indicate that yields at the long end of the Treasury curve have bottomed, at least in the short term. The IEF iShares 7-10 Year Treasury Bond ETF, another ETF, is sending the same message.
According to Katie Stockton, founder of Fairlead Securities, there is a chart pattern in the TLT that suggests a bottom may have formed. It’s known as an island reversal.
“An island reversal is a gap up that occurs after a long move. Then there’s the chasm in the opposite direction. “It creates a floating island on the price chart,” Stockton explained. “It could be another sign that Treasury bond prices have peaked.”
TLT and IEF both reached new highs on Monday, when yields fell precipitously. Bond yields move in the opposite direction of price, so when they fall, prices rise, and Treasury ETFs rise as well.
The 10-year Treasury yield is the most closely watched, as it serves as a benchmark and influences mortgage and other lending rates. Typically, when the 10-year yield fell this year, tech and growth stocks rose. It was a headwind for those stocks when it was rising.
However, as the yield continued to fall last week, investors became concerned that the bond market was foreshadowing economic trouble. On Monday, yields fell sharply, and stocks fell as well, on fears that the delta variant of Covid would force economic shutdowns, harming growth.
At the same time, the TLT surged higher, reaching a high of $151.95 on Monday during the stock market’s general sell-off. The 10-year yield, which is now at 1.28 percent.
“It appears that Monday was extreme enough. For a week, the TLT was bouncing. It made a short-term top, which means the yield may have made a low, which is what the market was worried about,”′′ said Scott Redler, partner at T3Live.com. “The move lower [in yields] felt more mechanical, rather than signaling that slower growth and recessionary times lay ahead.”
But Ben Jeffery, BMO’s U.S. rate strategist, isn’t ready to call a bottom, and he expects the 10-year to fall back to 1.10 percent as soon as next week.
He believes the 10-year yield will retest the 1.12 percent level reached Tuesday morning. “We believe we will get through that to 1.10 percent,” he says. “It’s likely to move sideways into next week, and as August progresses, we remain bullish.”
Chinese education stocks got downgraded
Over the weekend, Chinese regulators issued an official policy requiring after-school tutoring institutions to become non-profits, prohibiting foreign investment, and prohibiting the organization of subject tutoring during public holidays, weekends, and winter and summer vacation.
According to Goldman Sachs analyst Christine Cho and her team, the new rules will reduce the $106 billion after-school tutoring market by more than three-fourths in the next year, leaving it at only $24 billion.
Analysts downgraded the following stocks due to industry uncertainty and earnings risk:
From buy to neutral, TAL Education has you covered.
From buy to neutral in the New Oriental Education and Technology.
Gaotu Techedu has moved from neutral to sell.
Analysts maintained their sell rating on Koolearn, which is listed in Hong Kong.
Analysts said they were suspending their rating, price target, and estimates for 17 Education & Technology Group, which is listed in the United States, because there is insufficient information for the company, which is 100 percent exposed to the kindergarten to 12th grade business.
When copies of the harsh policy began to circulate in the United States and Hong Kong on Friday, shares of Chinese education companies plunged.
Notably, the rules state that foreign capital cannot own shares in after-school tutoring companies, including through the variable interest entity structure used by many Chinese companies to list in the United States.
As a result, according to the Goldman report, “profits obtained from operating K-12 [after-school tutoring] institutions may no longer be attributable to shareholders under the current contractual arrangement.”
While the new policy stated that violations must be addressed, the enforcement process was not immediately clear.
Potential benefits
Goldman analysts expect the after-school tutoring market to remain near $24 billion or less over the next four years, but they believe growth in other segments, such as adult foreign language courses, could benefit the businesses, particularly Gaotu.
“Management expects gross billings for the adult business to resume growth in 3Q21, along with the introduction of new products such as teaching certificate training and finance-related courses,” according to the report. “If we see any signs of revenue acceleration or successful subject/category expansion, we could turn incrementally more positive.”
The report also stated that new information for investors may be released when New Oriental and TAL Education report earnings. The financial results and management conference calls are scheduled for early August, on the 3rd and 5th, respectively.
