Source: Zhitong Finance
US stocks have risen one after another, and the rise in US bond yields may bring a new round of tests to the rise in US stocks.
Despite the accelerated rise in US Treasury yields in recent weeks, the expectation that the Federal Reserve will cut interest rates this year still drove the S&P 500 index to achieve a 10% increase in the first quarter, and US stock valuations also rose accordingly. According to LSEG Datastream data, the benchmark index's forward profit forecast is slightly higher than 21 times, the highest value since January 2022.
Currently, strong US economic data is weakening expectations that the Federal Reserve will cut interest rates this year. The 10-year Treasury yield, which is inversely proportional to the trend in bond prices, reached 4.4% on Tuesday, the highest level in more than four months.
So far, a strong economy, steady corporate profits, and the popularity of artificial intelligence have helped the US stock market to a large extent withstand the upward impact of US bond yields this year. However, some investors worry that if interest rates continue to rise, high valuations may make the US stock market more vulnerable. In addition to increasing capital costs for companies and households, higher yields will also increase the appeal of “risk-free” treasury bonds compared to stocks.
Chuck Carlson (Chuck Carlson), CEO of Horizon Investment Services (Horizon Investment Services), said, “(The yield) has broken through the previous upper limit. The trend in these interest rates is disturbing because what is currently being seen is a series of continuously rising highs, and these highs continue today.”
In recent years, the rise in US bond yields has led to a decline in US stocks several times. In September and October of last year, when 10-year Treasury yields soared to a 16-year high of just over 5%, US stocks were sold off, and when Treasury yields were reversed, US stocks rebounded dramatically. In 2022, the S&P 500 plummeted 19% as the Federal Reserve raised interest rates rapidly to stop inflation from soaring. On Tuesday, the S&P 500 index fell 0.7%, while the latest 10-year Treasury yield was around 4.35%.
An important reason investors are optimistic about rising yields this year is that the Federal Reserve has indicated its intention to cut interest rates in 2024. But strong economic data has led investors to doubt whether the Federal Reserve can significantly ease interest rates as previously anticipated.
The futures market on Tuesday showed that investors thought interest rates would be cut by about 70 basis points this year. Previously, in January, investors believed that interest rate cuts would exceed 150 basis points. This forecast falls short of the 75 basis point interest rate cut expected by the Federal Reserve.
At the same time, various metrics suggest that the attractiveness of US stock valuations has declined.
Keith Lerner (Keith Lerner), co-chief investment officer of Truist Advisory Services, said that the stock risk premium (comparing S&P 500 yield with 10-year Treasury yield) turned negative in the first quarter, the first time since 2002.
Edclissold, chief US market strategist at Ned Davis Research, said, “Bonds provide some real competitive opportunities. Therefore, if 10-year Treasury yields soar back to 5% like last fall, US stocks may reflect this, and their valuations will need to decline.”
Some investors believe that the pullback is too late. According to data from Bank of America Global Research, the S&P 500 index has not declined sharply since October last year, but historically it has retraced 5% or more three times a year on average.
Paul Nolte (Paul Nolte), senior wealth advisor and market strategist at Murphy & Sylvest Wealth Management, said, “We've been expecting a 3-5% pullback for a few months, and now it's probably close.”
Furthermore, the reaction of US stocks to rising US bond yields may depend on investors' opinions, that is, whether they continue to believe that economic fundamentals are still strong and that inflation is continuing to cool down.
Damian McIntyre (Damian McIntyre), head of multi-asset solutions at Federated Hermes (Federated Hermes), said, “If the increase in yield is due to economic growth being much stronger than expected, then investors will accept it. But if economic growth starts to slow and inflation rises, then investors will start to worry.”
Notably, this Friday's US employment data will be a test. If the report is stronger than expected, US bond yields may continue to rise. According to LSEG IBES data, the profit growth of the S&P 500 index is expected to reach around 10% this year.
Carlson of Horizon Investment Services said, “If profitable, US stocks can withstand many tests. However, if profits do not continue to exceed expectations, and interest rates on bonds now rise to a four-month high, US stocks will face a challenge.”
edit/lambor