Rising bond yields can be good for stocks when the economy is surging but in the current market, where stocks have rallied for more than nine years to record levels and the economy is starting to slow, that’s not the case. But at what level do rising bond yields turn bad for equities now?
Bank of America Merrill Lynch strategists say there’s no magic number, but if they had to pick one, it’s 5% for the 10-year Treasury yield.
That’s the level at which Wall Street’s average allocations to stocks peaks and interest in stocks wanes, according to Merrill’s sell-side indicator.
A 5% 10-year Treasury yield also indicates that stocks are trading at fair value to bonds, based on Merrill’s equity risk premium framework, and that risk-free Treasuries are favored over risky stocks, based on a risk/return basis. The S&P 500 is expected to return 5% annually over the next 10 years, according to Merrill’s valuation framework.
Lindsey Bell, investment strategist at CFRA, says a 4% yield is the level at which the 10-year Treasury becomes competitive with stocks. “The performance of stocks drop off sharply when the 10-year yield exceeds the dividend yield of the S&P by 200 to 300 basis points,” explains Bell. Given that the current dividend yield of the S&P 500 is 1.9%, stocks become less competitive to Treasuries when 10-year yield approaches 4%, according to Bell.
The 10-year Treasury note was yielding 3.24% in midafternoon trading on Wednesday, just below the seven-year high reached Monday, when the 10-year Treasury yield hit 3.25%, buoyed by Friday’s unemployment report showing the jobless rate at its lowest level in 49 years. By day’s end the 10-year Treasury yield had retreated to 3.19%, below the 3.21% close on Tuesday, but the major U.S. stock market indexes were off more than 3% from the previous close.