Analysis-Positive real yields may spell more trouble for U.S. stocks
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[April 20, 2022] By
Lewis Krauskopf
NEW YORK (Reuters) - A hawkish turn by the
Federal Reserve is eroding a key support for U.S. stocks, as real yields
climb into positive territory for the first time in two years.
Yields on the 10-year Treasury Inflation-Protected Securities (TIPS) -
also known as real yields because they subtract projected inflation from
the nominal yield on Treasury securities - had been in negative
territory since March 2020, when the Federal Reserve slashed interest
rates to near zero. That changed on Tuesday, when real yields ticked
above zero.
Negative real yields have meant that an investor would have lost money
on an annualized basis when buying a 10-year Treasury note, adjusted for
inflation. That dynamic has helped divert money from U.S. government
bonds and into a broad spectrum of comparatively riskier assets,
including stocks, helping the S&P 500 more than double from its
post-pandemic low.
Anticipation of tighter monetary policy, however, is pushing yields
higher and may dent the luster of stocks in comparison to Treasuries,
which are viewed as much less risky since they are backed by the U.S.
government. Graphic: Real yields turn positive,
https://graphics.reuters.com/
USA-STOCKS/YIELDS/xmvjoyogqpr/
chart.png
On Tuesday, stocks shrugged off the rise in yields, with the S&P 500
ending up 1.6% on the day. Still, the S&P 500 is down 6.4% this year,
while the yield on the 10-year TIPS has climbed more than 100 basis
points.
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"Real 10-year yields are the risk-free alternative to owning stocks,"
said Barry Bannister, chief equity strategist at Stifel. "As real yield
rises, at the margin it makes stocks less attractive."
One key factor influenced by yields is the equity risk premium, which
measures how much investors expect to be compensated for owning stocks
over government bonds.
Rising yields have helped result in the measure standing at its lowest
level since 2010, Truist Advisory Services said in a note last week.
Graphic: Equity risk premium shrinking,
https://graphics.reuters.com/USA-STOCKS/
REALYIELDS/
znvneqyljpl/chart.png HEADWIND TO GROWTH SHARES
Higher yields in particular dull the allure of companies in technology
and other high-growth sectors, with those companies' cash flows often
more weighted in the future and diminished when discounted at higher
rates.
That may be bad news for the broader market. The heavy presence of tech
and other growth stocks in the S&P 500 means the index's overall
expected dividends are weighted in the future at close to their highest
level ever, according to BofA Global Research. Five massive, high-growth
stocks, for example, now make up 22% of the weight of the S&P 500.
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A street sign for Wall Street is seen in the financial district in
New York, U.S., November 8, 2021. REUTERS/Brendan McDermid/File
Photo/File Photo
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At the same time, growth shares in recent years have been highly linked to the
movement of real yields.
Since 2018, a ratio comparing the performance of the Russell 1000 growth index
to its counterpart for value stocks - whose cash flows are more near-term - has
had a negative 96% correlation with 10-year real rates, meaning they tend to
move in opposite directions from growth stocks, according to Ohsung Kwon, a U.S.
equity strategist at BofA Global Research.
Rising yields are "a bigger headwind to equities than (they have) been in
history,” he said.
Graphic: Growth stocks growing share in S&P 500,
https://fingfx.thomsonreuters.com/
gfx/mkt/zgpomyqnlpd/Pasted%20image%201649962751839.png Bannister estimates the
S&P 500 could retest its lows of the year, which included a drop in March of 13%
from the index's record high, should the yield on the 10-year TIPS rise to 0.75%
and the earnings outlook - a key component of the risk premium - remain
unchanged.
Lofty valuations also make stocks vulnerable if yields continue rising. Though
the tumble in stocks has moderated valuations this year, the S&P 500 still
trades at about 19 times forward earnings estimates, compared with a long-term
average of 15.5, according to Refinitiv Datastream.
“Valuations aren't great on stocks right now. That means that capital may look
at other alternatives to stocks as they become more competitive,” said Matthew
Miskin, co-chief investment strategist at John Hancock Investment Management.
Still, some investors believe stocks can survive just fine with rising real
yields, for now. Real yields were mostly in positive territory over the past
decade and ranged as high as 1.17% while the S&P 500 has climbed over 200%.
JPMorgan strategists earlier this month estimated that equities could cope with
200 basis points of real yield increases. They advised clients maintain a large
equity versus bond overweight.
![](http://archives.lincolndailynews.com/2022/Apr/20/images/ads/current/rbc_towing_dailysda_SFARM_2022.png)
"If bond yield rises continue, they could eventually become a problem for
equities," the bank's strategists said. "But we believe current real bond yields
at around zero are not high enough to materially challenge equities."
(Reporting by Lewis Krauskopf in New York; Editing by Ira Iosebashvili and
Matthew Lewis)
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