The
is heading upward, like a hiker climbing on a mountain. And like a hiker, the yield reaches significant points—or levels.
For the 10-year, the next major key level is 5%—and Wall Street definitely won’t be applauding the milestone. Stocks would take a hit.
Today, the yield stands at just over 4.6%—almost a full percentage point higher than its February low of 3.8% and change. Driving it higher are two things: Hotter-than-expected inflation and the expectation that the Federal Reserve won’t cut short-term interest rates soon.
At 4.6%, the yield is certainly within striking distance of 5%. Even breaking above 4.7% would send a clear signal that the march isn’t over, writes John Kolovos, chief technical strategist at Macro Risk Advisors.
The yield rose to roughly 4.7% twice in April. Then, it promptly dropped because too many buyers showed up, sending the price of the bond up and the yield down.
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This time, if sellers are front and center—they would push the price down and yield up—the yield would drift higher. A 5% yield would be right there.
For the stock market, that’s a problem.
Right now, the
is almost 3% below its record intraday high after spiking on Friday. It is gaining again after a big drop a couple of weeks ago in no small part because stock traders are fairly calm for the moment—they still think the 10-year yield can fall if it doesn’t breach 4.7%.
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But get ready: A yield of 4.7% or higher could very well ruin Wall Street’s good move and drive equities lower.
A higher yield would raise the cost of borrowing—for consumers and businesses—making it more difficult for them to spend. The upshot of that: fairly slow economic growth, which could prompt analysts to reduce their earnings forecasts for companies.
A related concern is stock valuations.
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Higher yields on government bonds are appealing to investors who are jittery about steep valuations.
Right now, the S&P 500 trades at about 20 times analyst’s profit expectations for the coming 12 months, which means the earnings that investors receive by owning the index would yield them 5%—barely, if any, additional return versus a bond.
Stockholders want a higher rate of return as compensation for the added risk they’re taking. That’s why any meaningful move higher in the 10-year should trigger a selloff.
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If the yield rises above 4.7%, the S&P 500 should fall to 4800 from its current level of about 5100, based on the correlation between the index and the bond yield in the past few years, writes Kolovos. A yield above 5% would send the S&P 500 to about 4500, a 12% drop from its current level.
Watch that yield.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
