Forget Higher Interest Rates. This Could Kill the Bull Market.

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The New York Stock Exchange. Investors should be more concerned with what cash-rich companies have planned.


NYSE

There’s a saying that bull markets climb a wall of worry.

Investors are always looking for something to go wrong when things are going right. With stocks at or near all-time highs, investors have begun to fret over higher interest rates and their potentially negative impact on economic growth, coming inflation and what higher rates portend for stock-market valuations.

Higher rates, however, probably won’t kill the bull market. Corporate management teams might do that all on their own. New stock sales by companies already flush with cash is sending a coded message to investors that things might be as good as they get.

Interest rates are always a concern for the market and the overall economy. Higher interest rates make everything more expensive including home mortgages and car payments. It also makes it harder to start and grow businesses.

For the market, higher interest rates tend to depress price-to-earnings multiples. The reason is, essentially, math. If investors can make more interest on their bonds, they demand more return from stocks. Higher returns tomorrow means paying less for stocks today.

Here’s the thing. Inflation isn’t running wild. The yield on the 10-year Treasury bond is about 1.7%, up from recent lows, but lower than where yields finished 2019. That isn’t a high enough rate to choke off economic growth. At 3% and higher, the oxygen intake could start to get cut off.

Inflation expectations aren’t out of line with history either. Inflation expectations can be measured by the difference in traditional government bonds yields and the yield on government inflation protected securities. Essentially, the face value of an inflation protected bond goes up by the consumer price index. The difference in yield between the traditional bond and the inflation protected bond is the level of inflation required to make an investor the same return on both.

Today, the 10-year yield is at roughly 1.7%. The 10-year inflation protected yield is negative 0.7%. So inflation has to average about 2.4% for both bond holders to get the same return.

Investors should watch out for inflation, but they should be more concerned with recent stock sales by companies flush with cash.

QuantumScape

(ticker: QS),

Nikola

(NKLA) and

Canopy Growth

(CGC) are three cash-rich companies that have sold, or are planning to sell more stock.

QuantumScape is an electric-vehicle battery startup pioneering solid-state lithium anode batteries. It doesn’t generate significant sales. The company needs cash to carry it through to commercialization, expected by mid-decade. Still, QuantumScape ended 2020 with roughly $1 billion on the balance sheet. Its expected 2021 cash burn is less than $100 million. The company decided to raise about $400 million in a March stock sale anyway.

Nikola also doesn’t generate significant sales yet. It ended 2020 with about $840 million on its balance sheet, enough to build its first truck-making plant. But the company filed paperwork with regulators to raise more cash in mid-March.

As for cannabis company Canopy, it has about $1.5 billion in cash, less debt, on its balance sheet. Still, the company entered into a new credit agreement for $750 million at a rate of about 9.5%. What’s more, the company filed a paperwork to sell up $2 billion in new stock.

The three stocks are all down, by an average of roughly 15%, since they announced their capital-raising plans. All three have underperformed the

Dow Jones Industrial Average

and

S&P 500.

Investors and analysts appear to be a little worried, and a little perplexed, by managements’ plans. Stifel analyst
Andrew Carter,
for instance, wrote the Canopy actions left him with more “questions than answers.”

Growing confusion seems to capture overall market sentiment. The strategists Barron’s spoke with are watching stock sales, but no one was willing to say it portended bad things for the overall market just yet. The issue felt too new for them to have a definitive view on stock sales.

There is a growing body of data, however, showing the issue might become a larger concern. Follow-on stock offerings are up more than 100% year over year. Management teams are looking at the market, and current valuations, and deciding that now is a good time to sell.

The questions from here are, will management teams turn out right, and will investors reach the same conclusion shortly?

Write to Al Root at allen.root@dowjones.com.