To The Moon

6 Stocks That Stand to Get Hit by Bond Market Volatility

Bond market volatility is back -- and a handful of stocks are particularly susceptible to its gyrations.

It's been a wild year for Treasury investors. The yield on the two-year note peaked at about 5% in April, then dropped to a 2024 low of about 3.5% in September, when the Federal Reserve cut the short-term benchmark lending rate by half a point. Since then, the yield has risen to just over 4%.

The bond market isn't acting irrationally. It's aware that the economy -- and inflation -- have been stronger than expected, which means the Fed may not cut interest rates as much as it originally had planned. Also, the likelihood that Trump will win the presidential election has risen in the past few months, according to RealClearPolitics, further juicing expectations for inflation. Expect the swings to continue as Election Day on Nov. 5 nears.

Bond volatility has a way of rattling the stock market -- and it's especially problematic for companies with large amounts of variable-rate debt. That makes sense. The cost of borrowing fluctuates with rates, so when bond yields rise the companies have to pay more in interest, and less when yields fall. It's serious pressure because higher interest expense represents a greater portion of revenue, reducing net profit margin and lowering earnings. A drop in rates has an opposite, positive effect.

Only a tenth of all debt for large-cap companies is variable, so many of the impacted companies are small-caps, according to 22V Research founder Dennis Debusschere, who screened for companies with the highest quintile of variable debt within the broad-market S&P Composite 1500 index. Examples include aerospace and defense software and systems provider $Mercury(MRCY)$  , which has a market cap of $2 billion and has dropped 7% since late September; manufacturing component-maker $MKS Instruments(MKSI)$  , which has a market cap of $6.7 billion and has fallen 9%; internet and software company IAC, which has a market cap of $4.5 billion and has declined 4%; and $Callaway Golf(MODG)$  , which has a market value of $1.9 billion and has slipped 1.9%. The S&P 500 has risen 1% during the same period.

RH, the company formerly called Restoration Hardware, also made the list. The $6.1 billion luxury home-goods store has dropped 4.5% during the recent period that yields have gained, though it has risen 51% over the past year. The vast majority of the company's $2.5 billion in debt is variable.

An interest rate-driven drop could easily be a buying opportunity. Analysts expect sales to grow each year through 2027 to over $4 billion, according to FactSet. Not only is broader household spending expected to remain stable, but the company has been expanding internationally.

$Ford(F)$   is one of the few large-caps to make DeBusschere's list. The company has $150 billion in debt, the majority of it variable rate. Unusually, the stock has risen 2.3% since yields bottomed, thanks to General Motors' earnings, which painted a decent picture for auto demand. Ford is scheduled to report earnings of its own on Monday, and if the numbers look like $General Motors(GM)$  's, the stock could rise. Analysts expect Ford to report a profit of 46 cents a share on sales of $45.1 billion. Both projections have been revised lower in the past month, giving Ford an easier bar to hurdle.

It's a reminder that as much as volatility can shake investors, fundamentals are what ultimately matter.

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