Stocks are dropping. Yet this isn't all bad news

Stocks are dropping. Yet this isn't all bad news

An explosion of fear is ricocheting through financial markets as Wall Street sets hopes for the next step of the pandemic that may take place this spring and summer as vaccines increase and coronavirus cases decline.

What's going on: US stock markets, which have consistently reached all-time highs in recent weeks, took a leg lower on Thursday as concerns regarding inflation reemerged.The tech-heavy Nasdaq plummeted 3.5 per cent, the biggest downturn since October, while the S&P 500 lost 2.5 per cent.

The movements came as government bond yields, which shift opposite values, began to increase, signaling optimism in the economic recovery.But investors are also increasingly worried that a surge of activity later this year may cause prices to spike, pushing central banks like the Federal Reserve to roll back some of their support for the economy sooner than expected.

Government bond yields have jumped

The yield on the 10-year US Treasury note broke through 1.5% this week for the first time in a year.

0%

0.5%

1%

1.5%

2%

2.5%

3%

Apr. 2019

Jan. 2020

Oct. 2020

1.462%

Feb. 26

7:15 a.m. ET

Source: Refinitiv

Graphic: Julia Horowitz, CNN

The resulting market tantrum may be tough for some investors to swallow. But it shouldn't necessarily be cause for alarm.

The turbulence has its roots in good news. Wall Street is increasingly confident that the pandemic can be brought under control, and life can begin to return to normal. Spending in cash-starved sectors like travel and hospitality may soon jump, and companies that have been struggling could see earnings bounce back.

"It's a bad thing when yields are rising and growth expectations aren't," James Smith, developed market economist at ING, told me. That's not what's happening here.

It's true that the run-up in yields is happening very quickly. That could hurt companies that are sensitive to changes in interest rates. Governments sitting on huge piles of debt thanks to a wave of pandemic-era borrowing will also be watching the spike closely.

Yet it's worth remembering that any increase in yields is off of historic lows. Last March, the yield on the benchmark 10-year US Treasury note fell below 1% for the first time ever.

"You've had this rise in yields, but they're from quite extreme or unusual levels," Smith said. "This is a bit more of a normalization."

Market watchers predicted that this day would come, triggering a sell-off in high-growth stocks that have been popular during the pandemic. Apple (AAPL) shares shed 3.5% on Thursday, while Amazon (AMZN) dropped 3.2%.

One reason this class of stocks has been trading at such rich valuations is because bond yields have been rock-bottom. That's made riskier assets look more attractive.

"Down the line, bond yields may just rise, and equity valuations may also have to reset alongside yields," economist Robert Shiller, who is an expert on bubbles and developed the most famous method for valuing stocks, wrote in late November.

Here we are down the line, and the coming days or weeks could be bumpy. But strategists remain confident that with careful planning, investors will make it to the other side.