Bruised market eyes Treasury yields to gauge stock trajectory
“Investors are looking for a catalyst … and the catalyst they are currently focusing on is the direction of interest rates,” said Sam Stovall, chief investment strategist at CFRA.
Yields, which move inversely to bond prices, are rebounding from historically low levels and their recent rally is widely seen as a sign of economic strength.
Their rally follows the hawkish tilt of the Federal Reserve at its monetary policy meeting last week. The central bank has said it could start cutting its $ 120 billion-per-month government bond purchase program as early as November and potentially start raising rates next year, sooner than some believe. were waiting there.
Still, yield increases, such as the 27 basis point move recorded by the 10-year benchmark after the Fed meeting, could cloud the appeal of equities. The 10-year yield held around 1.47%, reducing gains towards the end of the week.
Stocks and bonds could draw inspiration over the coming week from developments in Washington, where lawmakers continue to debate an infrastructure spending program, as well as the monthly U.S. jobs report. next Friday.
Among the metrics investors use to gauge the future path of stocks is the spread between yields on two-year and 10-year Treasuries. Some see it as a barometer of whether the economy is slowing down or overheating.
A spread of between zero and 150 basis points is a “sweet spot” for stocks, which works out to an 11% annual return for the S&P 500, based on historical data, according to Ed Clissold, chief US strategist at Ned Davis Research. . The S&P 500 has averaged a 9.1% annual gain since 1945, according to CFRA’s Stovall.
This spread recently widened and stood at around 120 basis points on Friday. When the spread exceeds 150 basis points, “that’s when stocks tend to struggle,” Clissold said, which historically equates to an S&P 500 annual return of 6%.
“Too steep a curve means that inflation is getting out of hand and the Fed may need to tighten quickly,” Clissold said in a report this week.
The speed at which yields rise is also important, as is the economic and monetary policy environment, Goldman Sachs analysts said.
In a recent report, the bank contrasted the latest rise in yields with a peak of 50 basis points earlier this year.
While the previous hike reflected an improving economic outlook, now “economic growth is slowing, the (Fed) is expected to announce the start of the cut at its November meeting and our economists have lowered China’s economic growth forecast.” , wrote the bank analysts.
Higher yields put pressure on stock valuations by increasing the discount rate for future cash flows, a typical way of valuing stocks. Such pressure is particularly acute for tech stocks and other growth stocks whose valuations rely more on future earnings.
The S&P 500 technology index fell 2% against a drop of 0.9% for the overall index since the Fed meeting last week. Weak tech sector, which accounts for over 27% of the weight of the S&P 500, and other tech-related stocks, could cause problems for the broader index, even if higher yields benefit economically sensitive stocks such as banks.
Many investors still view stocks as more attractive than bonds despite rising yields. The equity risk premium, which compares the return on earnings on stocks to the return on 10-year Treasury bonds, currently favors stocks, according to Keith Lerner, co-chief investment officer at Truist Advisory Services.
While that premium has historically been at the level it hit at Wednesday’s close, the S&P 500 beat the one-year yield on the 10-year Treasury bill by an average of 10.2%, Lerner said.
“Rising returns, to a point, is healthy for the equity market,” said Matt Peron, director of research at Janus Henderson Investors.
(Reporting by Lewis Krauskopf; additional reporting by Noel Randewich in San Francisco; editing by Ira Iosebashvili and Richard Chang) (([email protected]; 646-223-6082; Reuters Messaging: lewis.krauskopf.thomsonreuters.com @ reuters.net, Twitter: @LKrauskopf))