Bond market warns of more pain for equities as 10-year yield hits 3%

Bond market warns of more pain for equities as 10-year yield hits 3%

Rising bond yields could indicate more trouble ahead for equities, especially now that the 10-year Treasury yield has bounced back above a critical threshold as U.S. equities sell off on Monday, several analysts said. Marketplace.

According to Nicholas Colas, co-founder of DataTrek Research, stocks are plummeting because the 10-year Treasury yield TMUBMUSD10Y,
3.038%
is on track to close above 3% on Monday for the first time since June.

The 3% level served as an important line for stocks dating back to the stock sell-off that took place during the fourth quarter of 2018.

“It’s like a clock,” Colas said in a phone interview with MarketWatch. “As yields approach 3%, markets are nervous. As they go above 3%, stocks fall.”

This pattern has already occurred once this year, as Colas and BTIG market technician Jonathan Krinsky have pointed out. The S&P 500 SPX index,
-2.07%
reached its lowest closing level of the year on June 16, just two days after the 10-year Treasury yield hit 3.48% – its highest level in more than a decade.

Years ago, the sensitivity of stocks to bond yields was rooted in the dividend yield investors earned simply by holding stocks, Colas explained. But over the past two decades, large companies have slashed their dividends, or eliminated them altogether, as investors began to favor stocks with the best prospects for revenue growth.

The S&P 500’s dividend yield is now approximately 1.5%, according to FactSet. But that doesn’t matter as much as the huge debt burdens on corporate balance sheets.

Companies went into debt after the Great Financial Crisis as the Federal Reserve and other central banks, including the European Central Bank, kept interest rates anchored at zero or below, driving corporate leverage to new highs.

This has resulted in the amount of outstanding corporate debt to US companies rising to more than 50% of gross domestic product, Colas said. To put that in context, the initial estimate of second-quarter GDP, released last month by the Bureau of Economic Analysis, put the size of the US economy at $24.85 trillion.

“When you have so much debt carried on a balance sheet, higher yields become problematic much more quickly,” he said.

Rising returns are also why many market strategists expect value stocks, a group that includes companies such as JPMorgan Chase & Co. JPM,
-1.79%
and International Business Machines Corp. IBM,
-1.81%,
will continue to outperform growth stocks, or a group that includes Netflix Inc. NFLX,
-6.16%
and Amazon.com Inc. AMZN,
-3.49%

Simply put: stocks with less debt on their balance sheets are better positioned to outperform in an environment of rising interest rates.

To see: Value stocks are posting the best stretch in 20 years relative to growth stocks – but that is starting to change. Because?

“That’s exactly why you’re going to have a shift to the value of growth. Companies with strong margins are likely to perform much better,” said Tavi Costa, portfolio manager at Crescat Capital.

US stocks continued to fall on Monday after the S&P 500 broke a four-week winning streak on Friday. The S&P 500 SPX,
-2.07%
fell 91 points, or 2.2%, in afternoon trading.

The Dow Jones Industrial Average DJIA,
-1.87%
dropped 650 points, or 1.9%, to 33,055, while the Nasdaq Composite COMP,
-2.47%
fell 313 points, or 2.5%, to 12,391.

All three indices were on track for their biggest one-day drop since June. In comparison, the 10-year Treasury yield TMUBMUSD10Y,
3.038%
rose 4.6 basis points to 3.028%.

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