Stocks have gained ground so far this year. Above, a scene from the New York Stock Exchange.
NYSE
When bond yields have risen recently, stocks have fallen. And vice-versa. That’s bound to change as markets worry about economic growth.
Over the past year, the 10-year Treasury yield has climbed to just over 3.5% from just under 1.8%. In that time, the
S&P 500
is down almost 9%, a loss that was worse a few months ago. The reason for these moves is that the Federal Reserve has been lifting interest rates to cool inflation by reducing demand for goods and services.
While rate increases by the Fed usually boost yields on Treasury debt, they also hit corporate profits and stock valuations, not to mention raising concern about a potential recession, so it makes sense that stocks have been sliding when yields rise. Signs that the Fed can win the fight against inflation, meanwhile, raise hope that the central bank will continue to ease up in raising rates, allowing yields to fall as stocks gain.
While some expect stocks and yields to stop moving in opposite directions, they haven’t yet. The 10-year yield is down from just over 3.8% to start the year, while the S&P 500 is up about 5%. Strategists at Evercore call that relationship “virtuous.”
But one of these days—and potentially soon—that inverse correlation will reverse itself. That would mean stocks and the 10-year yield rise and fall in parallel.
Yields on 10-year U.S. government debt now look fairly attractive at a bit over 3.5%, considering that expectations for average annual inflation over the next decade are around 2.3%, according to St. Louis Fed data. Anyone who buys the debt would receive a real, inflation-adjusted yield of just over one percentage point.
That’s appealing, especially because stocks could start teetering again. Investors could plow into the safety of bonds as the Fed’s seven rate increases last year weaken the economy, putting corporate profits and the stock market at risk. Higher bond prices send yields downward.
Even if bond prices were to fall enough to push yields on the 10-year note up a bit, buyers likely would step in and bring them lower again, said Kevin Simpson, founder of Capital Wealth Planning.
As investors buy bonds, they might sell stocks because of the earnings risk they carry. Analysts have recently been reducing their forecasts of corporate earnings, and the cuts could keep coming for some time. The latest data on economic growth—gross domestic product increased at a 2.9% annual rate last quarter—show the economy has yet to slip into a recession, but if it does, that would be a reason to buy bonds as a haven.
Falling yields on bonds—the result of that buying—would come as a weaker economy hit stocks. Investors in stocks would then hope to see higher yields on bonds as a sign the people are more optimistic about the economy.
According to strategists at
Bank of America,
investors might be well advised to sell stocks because the market may be near the point where stock prices and bond yields rise and fall at the same time. That would break the recent pattern.
Watch the 10-year yield. If drops significantly, signaling a rush into the safety of bonds as fear of a recession mount, that might be a signal to lighten up on stocks—not buy more.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
Credit: marketwatch.com