almost 3 years ago • 2 mins
Long-term US government bonds haven’t had such a bad start to a year since 2009.
When bond prices fall, their yields rise. And investors have been squarely focused on 10-year US government bonds lately: their yields rose from 1% to 1.5% last month, sparking a sudden selloff in stock markets as well as a slew of questions from Finimizers. I thought I’d have a go at answering four of the most important ones.
💡 In short, no. Over the last three years, stock market returns have been strongest when real (i.e. inflation-adjusted) yields were falling and “breakeven inflation” (the difference between the unadjusted yield of a bond and the real yield on its inflation-linked equivalent) was rising. And while both breakeven inflation and real rates have been rising in recent weeks, US stock prices also tend to do well in that environment.
💡 Because yields rose too far too fast. In months where US 10-year government bond yields rise by more than two standard deviations, the country’s S&P 500 stock index has historically averaged a 5% drop. Put another way, if 10-year yields had risen 0.3 percentage points last month, you might have reasonably expected stocks to fall 5%. Yields in fact rose 0.5 percentage points (from 1 to 1.5%) in February...
💡 When US 10-year government bond yields exceed 3.5%. According to strategists at investment bank Goldman Sachs, the complex relationship between bond yields and the “equity risk premium” – the additional baseline return an investor demands for buying riskier stocks over safer bonds – suggests that as 10-year yields approach 4%, stocks will have to offer more earnings growth in order to remain as attractive.
💡 Cyclicals and value stocks. Rising rates typically drive an investor rotation away from defensive-sector bets and fast-growing companies and towards economically sensitive “cyclical” sectors and cheap-looking value stocks. Looking ahead, investors will have to balance the appeal of backing firms with high long-term growth potential against the risk that rates rise further and stock prices continue to outperform elsewhere.
To recap, then: don’t panic, keep an eye on the direction (and pace) of future US 10-year government bond yield changes, and perhaps consider tweaking your stock portfolio more towards value and cyclicals.
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