The NYSE flat the last day. Rising bond yields make investors wonder when treasuries will be more attractive than stocks.
Courtesy of NYSE
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After a long reduction in long-term Treasury yields, the 30-year-old has just risen above 2% for the first time since Covid-19 arrived. This makes investors wonder when the broader trend of rising bond yields will hurt the stock market.
The main concern is that once Treasury yields rise enough, investors will want to buy insurance bonds instead of high-yield stocks or debt. But it is unclear when it will occur and the 30-year bond carries an additional risk of loss as yields continue to rise. As for the ten-year note, a more popular benchmark, The Wall Street consensus is hard to come by: forecasts from strategists say ten-year Treasury yields should rise to just 1.75%, or up to 5%, to make them more attractive than those alternatives. riskier.
Long-term Treasury yields have risen steadily since late August and more rapidly since November 9, when
Pfizer
and BioNTech announced an effective vaccine against Covid-19. The 30-year yield stood at about 2% on Monday after failing to break that level in the morning trade, up from 1.6% before the vaccine. Yield at 10 reference years has also risen, rising to 1.2% on Monday, from 0.8% before the vaccine.
Long-term yields had fallen from Monday morning highs amid concerns about the distribution of the Covid-19 vaccine and the pace of global economic reopening, with a ten-year yield of one basis point (one hundredth) percentage) and a 30- year yield drops three basis points.
But expectations remain that yields will continue to climb over the coming weeks and months. And a key issue is how high yields should be to hurt stock market returns. Several Wall Street strategists have addressed this puzzle in recent notes.
Nearly 70% of S&P 500 companies pay higher than the ten-year note, wrote a team led by capital strategist Savita Subramanian in a recent note. This proportion would fall to 40% if companies keep their payments at current levels and Treasury yields increase to 1.75% by the end of this year, they found.
This could begin to undermine the attractiveness of stocks as a revenue stream; today the overall dividend yield of the S&P 500 is 1.5%, higher than the three-year Treasury payment. This has helped offset concerns about valuations above historical averages.
Still, the picture looks much better for stocks from a total return perspective. The long-term implicit return on the S&P 500 is around 3%, the bank’s equity strategists wrote.
Wall Street strategists don’t expect the ten-year note to be able to challenge that return soon. In a January perspective,
bank of america‘s
interest rate strategists predicted that 3% will be the maximum benchmark yield during this expansion, implying that yields will not reach these levels until the Fed begins to raise interest rates. And, according to some of the bank’s valuation models, alike, stocks will look cheap compared to Treasuries until yields increase by up to 5%.
More importantly, a 3% return on the S&P 500 will still surpass a key market indicator of inflation expectations over the next decade. This indicator, called the equilibrium inflation index, has been driven upwards by the improvement in growth expectations as the US recovers from the Covid-19 crisis. On Monday it reached 2.2%, the highest level since 2014.
In contrast, the ten-year Treasury yield remains below market inflation forecasts during this period and is expected to remain so until at least the end of this year. Even higher inflation-adjusted yields may not hurt equities, wrote Credit Suisse strategist Jonathan Golub in a Feb. 8 note, as rising stocks from stronger economic growth would have of overcoming the relative improvement in bond market performance.
As a positive for equities, the increase in returns does not negatively affect the balance sheets of large-cap US companies. The effective performance of the ICE BofA Corporate Index, an indicator of current borrowing costs for highly rated companies, remains at 1.9% only for a maturity of nearly 12 years. And last year’s record flood of fixed-rate loans means companies won’t have to refinance their debt for years.
There is a way that rising rates negatively affect at least some stocks: investors are less willing to wait for profit growth,
Goldman Sachs
the strategists wrote in a February 7 note. Shares sensitive to economic growth and “value” stocks that performed lower than the pandemic have outperformed 10-year yields that rose above 1%, they found, because investors are discounting flows of future cash at a higher rate. The Russell 2000 Value (IWN) ETF has risen 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 actual damage would require yields to rise 36 basis points within a month. It seems unlikely, given that it took about three months to climb so far during the last move that caught my attention.
Of course, increasing returns will likely require some changes in the way money managers who allocate cash in different markets make decisions, strategists and investors say. The DE Shaw hedge fund recently discovered that long-term bonds should serve as better hedging against stock market crashes as yields increase.
Therefore, bonds will likely be marginally more attractive in the coming months. But it is not clear that this change is enough to undermine equities, especially since long-term bond yields are at the highest risk for rising yields. So while Treasuries might provide a better alternative to stocks someday, this process could take longer than investors might think.
Write to Alexandra Scaggs at [email protected]