In previous articles, I've highlighted the strong correlation between the direction of bond yields and the return to Free Cash Flow yield (FCF yield - Free Cash Flow per share divided by current share price). This correlation is because value stocks, with their shorter-duration cash flows, are more resilient to increasing rates than growth stocks with longer-duration cash flows. This post is an update about what stocks appear to be pricing for the direction of interest rates.
The chart clearly shows interest rates and value stocks' (based on FCF yield) tendency to move together. The return to FCF yield (orange line) has been especially strong for the past year. (This factor return is for a portfolio of stocks from the top 500 market stocks in the US that is long-short, sector-neutral, monthly rebalanced, sorted based on FCF yield). When the 10-year bond yield (blue line) strayed from the path set by the FCF yield factor return, it reverted to maintain the strong correlation. Corporate cash flows have been signaling higher rates. That trend has not yet changed.
