With stocks soaring and bonds sliding, the relationship between equities and debt instruments is being looked at in a number of different ways. Investors are questioning whether stocks and bonds can move up at the same time, meaning bond prices are rising but yields are falling.
A recent article in the Wall Street Journal featured statements from Bank of America Merrill Lynch and from Goldman Sachs.
“The best S&P 500 returns have occurred when the 10-year Treasury yields has ranged from 2% to 3%, particularly when yields have been rising,” writes Bank of America Merrill Lynch’s Savita Subramanian. “While average historical stock returns remain positive until interest rates cross above 6%, the probability of losing money begins to increase as interest rates cross above 3%.”
“A rise in rates to 4.5% by year-end would cause a 20% to 25% decline in equity prices,” Goldman economist Daan Struyven says in a note highlighted by Bloomberg.
Both of these statements focus on the rate itself, but I noticed something different. Looking at the two most recent bear markets and a recent correction, I took note of how the 10-year yield spiked ahead of the downswings. From October ’98 through January ’00, the 10-year yield jumped from 4.1 percent to 6.8 percent. The S&P saw choppy action for the first nine months of ’00 before the bear market started later that year. From June ’03 through June ’07, the yield rose from a low of 3.07 percent to a high of 5.32 percent. Once again we saw volatility on the S&P increase and approximately five months later the bear market started. From December ’08 through April ’10, the yield rose from 2.04 percent to 4.01 percent. From the April high that year to the July low, the S&P dropped over 17 percent and was the first major correction after the bear market ended in ’09.
The percentage changes differ greatly on the three bond slides because of how high rates were in ’98 and ’03. The systematic decline in the 10-year treasury yield goes all the way back to 1981. What I took note of was how these three periods saw the yield jump by two percent. We see it in all three cases. The jump from mid-2012 to late 2013 was only an increase of 1.64 percent, so it didn’t match the move of the other three. So far in the current bond slide, we have seen the yield climb by 1.6 percent. The red line represents where the yield would have to get to for the rise to become a two-percent one (3.34%). We have already seen a minor correction and an increase in volatility, but we have a ways to go before the two-percent increase would hit.
I have marked the periods where we saw the 10-year yield jump by two percent on the chart of the S&P above. I also took note that the current rally will be nine years in the making next month and the S&P has gained 331 percent from the ’09 low to the recent high. From September ’91 through September ’00, the S&P gained 300 percent and it was a nine-year stretch.
This could all be circumstantial evidence, but it could also be valid. When the spending habits of companies and individuals get used to low borrowing rates and then the rates change by two-percent or more, it affects their ability to spend and to keep the economy growing. I have been concerned about the market rally for some time now due to the length of the rally and the severe upward slope it has taken in the past year and a half. I haven’t started shifting assets out of stocks yet, but I am watching a number of different indicators for any signs that this bullish phase is over. I will be watching the 10-year treasury yield more closely and if it hits 3.34 percent I will certainly take it in to consideration along with a number of other indicators.