After a long spike in long-term Treasury yields, the 30-year market has just risen above 2% for the first time since Covid-19 crashed. This makes investors wonder when the broader trend in rising bond yields will affect the stock market.
The central concern is that, when Treasury yields rise enough, investors will want to buy safe bonds instead of high-yield stocks or debt. But it is unclear when this will happen, and the 30-year bond carries an extra risk of loss as yields continue to rise. When it comes to the 10-year banknote, a more popular reference, The Wall Street consensus is hard to find: strategists’ predictions say that 10-year Treasury yields may need to increase only to 1.75%, or even 5%, to make them more attractive than the riskier alternatives .
Yields on long-term Treasury bonds have steadily increased since the end of August, and more rapidly since November 9, when
Pfizer
and BioNTech announced an effective vaccine against Covid-19. The 30-year yield was hovering close to 2% on Monday after breaking that level in the morning trade – up from 1.6% before the vaccine. The 10-year reference yield also rose, rising from 0.8% before the vaccine to 1.2% on Monday.
Long-term yields had fallen from their morning highs on Monday afternoon amid concerns over the distribution of the Covid-19 vaccine and the pace of the global economic reopening, with the 10-year yield below a base point (hundredth percentage point) and 30- annual yield fell three basis points.
But the expectation remains that yields will continue to rise in the coming weeks and months. And a key question is how high the yields must be in order to decrease stock market returns. Several Wall Street strategists have solved this puzzle in recent notes.
Nearly 70% of S&P 500 companies pay a higher yield than the 10-year note, a team led by equity strategist Savita Subramanian wrote in a recent note. That proportion would drop to 40% if companies kept their payments at current levels and the Treasury’s income increased to 1.75% by the end of this year, they found.
This could start to undermine the attractiveness of stocks as an income game; today, the overall dividend yield on the S&P 500 is 1.5%, higher than the payment from the Treasury in 10 years. This helped to offset concerns about ratings that are higher than historical averages.
However, the image looks much better for stocks from a total return perspective. The long-term implicit return on the S&P 500 is about 3%, the bank’s stock strategists wrote.
Wall Street strategists don’t expect the 10-year note to be able to challenge that return anytime soon. In an article on the January outlook,
Bank of Americain
Interest rate strategists have predicted that 3% will be the peak of the benchmark yield during this expansion, which implies that yields will not reach those levels until the Fed starts raising interest rates. And according to some of the bank’s valuation models, everything else equal, stocks will look cheap compared to Treasury bills until yields increase to 5%.
More importantly, a 3% return on the S&P 500 will still exceed a key market indicator of inflation expectations in the next decade. This indicator, called the implied inflation rate, was driven by an improvement in growth expectations as the United States recovers from the Covid-19 crisis. On Monday, it reached 2.2%, the highest level since 2014.
The 10-year Treasury yield, in contrast, remains below market inflation projections over that period and should remain so until the end of this year, at least. Even higher inflation-adjusted yields may not hurt stocks, wrote Credit Suisse strategist Jonathan Golub in a February 8 note, as the momentum that stocks get from stronger economic growth should outweigh the relative improvement in the market. income securities.
In another positive aspect for stocks, the increase in earnings is not negatively affecting the balance sheets of large-cap American companies. The effective yield of the ICE BofA Corporate Index, an indicator of current borrowing costs for highly rated companies, remains at just 1.9% for a period of almost 12 years. And last year’s record-breaking flood of fixed-rate loans means that companies won’t have to refinance their debts for years.
There is a way in which rising rates are negatively affecting at least some stocks: investors are less willing to wait for profit growth,
Goldman Sachs
strategists wrote in a February 7 note. Stocks that are sensitive to economic growth and “value” stocks that underperformed during the pandemic have outperformed since 10-year yields rose above 1%, they found, because investors are discounting future cash flows at a highest rate. The Russell 2000 Value ETF (IWN) is up 14% so far this year.
Goldman strategists wrote that a quick jump in Treasury yields would be dangerous for the stock market as a whole. But the bank estimated that the real damage would require yields to increase by 36 basis points over a month. This seems unlikely, considering the fact that yields took about three months to rise so much during the last bullish move that it drew attention.
Of course, rising yields are likely to require some changes in the way money managers who allocate money in different markets make their decisions, say strategists and investors. The DE Shaw hedge fund recently discovered that long-term bonds should serve as better protection against falls in the stock market as yields increase.
Therefore, the titles are likely to become a little more attractive in the coming months. But it is not clear whether this change will be enough to undermine stocks, especially since long-term bond returns are at the greatest risk with rising yields. So while Treasury bills may offer a better alternative to stocks someday, that process can take longer than investors can imagine.
Write to Alexandra Scaggs at alexandra.scaggs@barrons.com
