The 30-year Treasury yield very nearly touched the 5.7% level recently, the highest it’s been since 2002. The 10-year yield touched 5.34%, also a 24-year high. Since the early March low, both yields have risen well over 100 basis points each. Inflation, debt, and geopolitical risks are largely to blame.
So far, stock investors have been mostly unaffected. The S&P 500 (^GSPC +0.47%) is still near an all-time high. Volatility is relatively contained, but credit spreads are finally showing some signs of stress. Should stock market investors be worried about what’s happening in the bond market?
The two are unquestionably linked but not directly correlated. The factors that are impacting yields right now are headwinds for equities, but the artificial intelligence (AI) tailwind is helping offset the downside risks at the moment.
Rising yields don’t signal that a market crash is imminent, nor do they suggest that a recession is right around the corner. Stocks have remained remarkably resilient despite the bond market sell-off, but the current risks to them shouldn’t be ignored.
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Why high Treasury yields matter to stocks
Treasury yields serve as a benchmark for borrowing costs throughout the economy. They impact everything from home mortgages to business loans to credit card debt.
When yields rise, all of these forms of financing can become more expensive. Right now, the average 30-year mortgage rate is at a 3-year high while mortgage applications and pending home sales figures are dropping. Higher borrowing costs can slow consumer and business spending and eventually act as a headwind to corporate profits.
The trickle-down effect to corporations’ bottom lines is when higher rates become a problem for stocks. If consumers have less money to spend and businesses become hesitant to invest in growth because they need cash for other purposes, revenue and earnings can begin to slow.
The other problem for stocks is that higher yields make fixed income more attractive as an alternative. Coming out of the COVID recession, few people wanted to buy a 30-year Treasury bond that was yielding just 1% to 2%. Now that investors can lock in a 5.7% (theoretically) risk-free annual yield for the next three decades, they might consider shifting money from stocks to bonds to potentially improve the risk/reward trade-off.
Yields can rise for good and bad reasons
Yields rise and fall every day for a number of reasons. These moves aren’t necessarily good or bad. But they do need to be taken in the context of the economic conditions around them. I’d say right now that yields are rising for both good and bad reasons.
On the downside, inflation remains above the Fed’s 2% target and has been for several years. The more prices rise, the more yields tend to adjust higher to cool pricing growth. For the same reasons mentioned earlier, this tends to slow growth and consumer spending and stocks may fall as a result of it.
On the other hand, strong economic growth can also lead to higher rates. The AI boom has created a huge acceleration in both corporate revenues and profits, particularly in the tech sector. GDP growth is still expanding at a decent rate, and the unemployment rate is still just above 4%. All of these numbers point to a healthy economy.
But faster growth can also lead to inflation. Rates often rise in these situations to balance growth with price control.
Here’s what I’d do right now
Acknowledge that current conditions are creating uncertainties for stocks, but don’t rush to make major asset-allocation changes in your portfolio.
The combination of higher inflation and higher interest rates isn’t a good thing for stocks. But healthy corporate earnings and GDP growth also suggest that a sharp drawdown in stock prices is unlikely. No one factor exists in isolation, and investors need to consider the sum total of all parts.
If you’re a long-term investor, I don’t see any good reason to make major portfolio changes unless your objectives or risk tolerance have meaningfully changed. Any attempt to de-risk ahead of a predicted bear market is very likely to fail and usually isn’t worth it.
I think Treasuries become more interesting as yields rise, but more on the short end of the curve as an income opportunity. Investing in long-term bonds is really just a bet on the direction of interest rates, and who knows how that will turn out.
But keep doing the things you can control. Keep contributing to your investments, rebalance if necessary, and prepare yourself mentally now to handle any situation that might arrive in the future.
