Rising bond yields haven't kept tech stocks from outperforming - and have created this buying opportunity, says BlackRock

By Christine Idzelis

'The risk of only two Fed rate cuts now appears higher than the risk of four cuts,' says BlackRock's chief investment and portfolio strategist for the Americas

This year's rise in Treasury yields hasn't keep technology stocks from outperforming, while for bond investors, higher interest rates present a buying opportunity, according to BlackRock.

The recent backup in rates "is probably the last best opportunity to extend duration," said Gargi Pal Chaudhuri, BlackRock's chief investment and portfolio strategist for the Americas, in her iShares spring outlook note this week.

Treasury yields have jumped in 2024, sending down prices for U.S. government debt and creating a buying opportunity for bond investors ahead of highly anticipated rate cuts by the Federal Reserve, according to Chaudhuri.

But investors should pick bond durations "really carefully," she said in a phone interview, and "take a little bit of duration."

Chaudhuri said she favors reaching only so far out into the yield curve as the five-year point, as the "belly of the curve" is less sensitive to rising rates than longer-term Treasury bonds. While short-term Treasury yields should eventually fall when the Fed cuts rates, she said in her note that yields on the long-end of the curve may go up on "rising term-premium and supply concerns."

With bond yields and prices moving in opposite directions, long-term Treasury bonds have been particularly hurt by the recent backup in rates. For example, the iShares 20+ Year Treasury Bond ETF TLT has lost 6% this year through Wednesday on a total-return basis.

Meanwhile, the iShares 3-7 Year Treasury Bond ETF IEI, which targets the belly of the yield curve, has fared better, losing a total 1.1% this year over the same period, FactSet data show.

Chaudhuri suggested that investors could consider other exchange-traded funds, such as the iShares 1-5 Year Investment Grade Corporate Bond ETF IGSB or iShares 0-5 Year TIPS Bond ETF STIP. Both funds are in the green so far in 2024.

The iShares 1-5 Year Investment Grade Corporate Bond ETF has seen a total return of 0.5% so far this year through Wednesday, while the iShares 0-5 Year TIPS Bond ETF has gained 0.8% on a total return basis over the same period, according to FactSet data.

A duration of five years in fixed income seems like a "sweet spot," said Chaudhuri by phone.

"A cautious Fed, stronger growth, normalizing inflation, and a strong labor market may reward investors for owning bonds and keeping their duration contained around the five-year part of the curve," according to her note.

In her view, bond investors may preserve more return than long-dated Treasurys should the yield curve steepen on worries over an expected rise in supply of U.S. government debt.

The yield on the 5-year Treasury note BX:TMUBMUSD05Ywas trading around 4.34% on Thursday afternoon - about the same level as the 4.35% rate on 10-year Treasurys BX:TMUBMUSD10Y, FactSet data show, at last check.

This year the yield on the 10-year Treasury note has jumped 49.4 basis points to 4.354% as of Wednesday based on 3 p.m. Eastern time levels, according to Dow Jones Market Data. Bond yields and prices move in opposite directions .

While the Fed has projected that it will begin cutting rates this year as inflation has eased significantly from its 2022 peak, it has also indicated that it's in no rush to do so against the backdrop of a still strong labor market.Treasury yields have recently backed up amid signs of a resilient U.S. economy despite the Fed hiking interest rates to bring down inflation.

"Our base case is that the Fed engineers a soft landing and starts to cut rates in the second half of the year," Chaudhuri wrote in her spring outlook note. "The downside risks to economic growth have diminished, so the risk of only two Fed rate cuts now appears higher than the risk of four cuts."

Before lowering its benchmark rate, the Fed needs to be confident that sticky inflation in the U.S. will keep falling toward its 2% target, according to her note.

Tech stocks outperform

The rise in Treasury yields in 2024 hasn't kept major U.S. equity indexes from climbing, with tech stocks outperforming the broader market regardless of the macro backdrop, according to the BlackRock note from Chaudhuri.

The chart below shows the outperformance of the Russell 1000 Technology index versus the S&P 500 as 10-year Treasury yields fell in the fourth quarter and then climbed in the first three months of this year.

"The weight of higher rates can still be observed in small-cap equities and non-AI exposed sectors, where higher rates and expectations of slower real growth have dampened earnings expectations and therefore performance," Chaudhuri wrote. "This has led to narrow leadership, where a select few names can buck the overall trend."

Artificial-intelligence related companies have disrupted historical macro relationships in the market, with her note suggesting ChatGPT has impacted the price performance of value versus growth stocks when viewed against the trajectory of 10-year Treasury yields.

"We are continuing to tell our clients that the quality theme is still one that is going to resonate in this environment," Chaudhuri said by phone. She said companies with the most "earnings power" should continue to outperform in the next few months.

Chaudhuri pointed to the iShares MSCI USA Quality Factor ETF QUAL as an example of a fund providing equity exposure to the quality theme. The fund's top holdings include large-cap tech stocks such as Nvidia Corp. (NVDA), Microsoft Corp. (MSFT), Broadcom Inc. (AVGO), and Apple Inc., as well as positions in areas such as financials, healthcare and communication services.

For example, Facebook parent Meta Platforms Inc. (META), Visa Inc. (V) and pharmaceutical company Eli Lilly (LLY) were among its top 10 holdings as of April 3, according to data on BlackRock's website.

The U.S. stock market was climbing on Thursday, with the Dow Jones Industrial Average DJIA up 0.4%, the S&P 500 SPX rising 0.7% and the tech-heavy Nasdaq Composite COMP climbing 1.1%, FactSet data show, at last check. So far this year, the S&P 500 is up around 10%, after notching a series of record closing highs in 2024.

-Christine Idzelis

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04-04-24 1438ET

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