Rising bond yields change the calculus of stocks

Bond yields are trading at their highest levels in more than a decade.

This poses another threat to the stock market, which has struggled to find a foothold this year.

When interest rates were at their lowest, as they were after the 2008 financial crisis and then again after the pandemic, it was easy for investors to justify putting money in the relatively risky stock market. The returns they would get on stocks would always outweigh what they could get from government bonds with yields close to nothing – prompting Wall Street to declare that there was “no alternative” to stocks.

This dynamic has been turned upside down this year. After Several Fed Rate Increases, Yields Across the Treasurys . Market It has risen to its highest level in several years. Now, less than 16% of S&P 500 stocks have greater dividend yields than the two-year US Treasury bond yield, according to Strategas. Less than 20% have a dividend yield greater than the 10-year bond yield, which on Monday reached 3.489%, its highest since 2011. Those numbers represent the lowest share since 2006.

Many investors chose to take risks in the stock market because there was no return available anywhere else. Now is the time people think, “Do I really need to take the risk?” said Katie Nixon, chief investment officer at Northern Trust Wealth Management.

US stocks opened lower on Monday but then pared their losses, with the S&P 500 ending 0.7% higher and the Dow Jones Industrial Average rising 0.6%, or 197.26 points. Major indices are still down for the year: the blue-chip index is down 15% in 2022, while the S&P 500 is down 18%.

Whether or not markets get any reprieve depends in part on what happens at the end of the Federal Reserve’s policy meeting on Wednesday.

Traders see an increase in interest rates as a consequence imposed on them. Fed Funds Futures Tracked

CME مجموعة group

The market is showing a 100% probability that the Federal Reserve will raise interest rates by at least three-quarters of a percentage point.

Investors say that what is less certain is what Fed Chairman Jerome Powell will say at the press conference that will follow the central bank meeting. markets fainted last month After Powell said the central bank will keep raising interest rates until he feels confident it has got inflation under control, even if it hurts the economy. Investors who have largely given up their hopes on the Fed’s pivot are now keen to make two things clear: how long higher interest rates will last by the end of the rate hike campaign, and how long they will be there.

Oil prices rose early this year, driving up inflation and making energy stocks the best performing S&P 500 this year.


picture:

Scott Olson / Getty Images

“The Fed statement will be everything,” said Louis Navellier, chief investment officer at Navellier & Associates. “We need light at the end of the tunnel.”

Mr. Navelier estimates that he has put 60% of his investment portfolio in the energy sector this year. This is the choice that paid off Strong inflationary pressures Energy stocks have made the S&P 500 sector by far the best performer this year.

“All I care about is finding the silver window. But this window is getting narrower,” Navelier said, adding that it was becoming more and more difficult to pick the winning stocks.

So far, the data has not been on the investors’ side.

Federal Reserve Chairman Jerome Powell said the central bank should keep raising interest rates until it makes sure inflation is under control. He spoke at the Federal Reserve’s annual symposium in Kansas City, Wyoming. Photo: Jim Urquhart/Reuters

Money managers got a glimmer of hope last month when the Labor Department’s Consumer Price Index report showed inflation had eased slightly from multi-decade highs in July. But the ministry’s latest report, released last week, fails to show that this trend is continuing. Core CPI, which excludes volatile food and energy prices, rose 0.6% in August from the previous month, double speed july.

“In my view, that starts the clock,” said Brad Conger, deputy chief investment officer at Hertel Callahan & Co., referring to the Fed’s desire to see data over several months before deciding that inflation is easing enough to slow it. Its rate increases. “For equity investors, this is a challenging background,” he added.

Meanwhile, increases in Fed interest rates also threaten to put more pressure on an already slowing economy. Mortgage rates last week jumped above 6% For the first time since the 2008 financial crisis, higher borrowing costs have led to Existing home sales decline For six consecutive months.

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Consumer spending in other areas remained strong, including clothing, food, and expensive items such as cars. Corporate earnings have also proven better than feared, even as companies have been hurt by rising costs of everything from shipping to raw materials to wages, and the labor market continues to be a bright spot for the economy.

However, investors say they can’t help but wonder how long these trends will last, especially since the Fed does not appear close to making its rate increases.

Bond traders are currently pricing in a final rate — the peak of the fed funds rate in the rate increase cycle — of about 4.41% in April, according to FactSet.

Some economists argue that the Fed has raised the final interest rate.

Nomura

Economists expect a final rate of 4.5% to 4.75%, up half a percentage point from their previous call.

German Bank‘s

The chief US economist sees the fed funds rate rising to 5%.

At this point, Ms. Nixon said, it appears that a lot of the bad news hanging over investors’ heads has already been priced in by the markets.

Even with that in mind, Nixon said, it’s hard to see an easy path higher for markets, given the combination of monetary tightening, slowing growth both in the US and globally, and above-trend inflation.

“What is the catalyst to push the markets higher? This is where things in the short term are still very murky.

Write to Akane Otani at akane.otani@wsj.com

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