How Treasury Bonds Affect Your Stock Portfolio

Modern portfolio theory loosely states that it is the composition of stocks, bonds, and cash as a class that makes a difference in returns, not a particular stock or bond.  It is whether you are in stocks or bonds as an aggregate, as opposed to owning IBM or Microsoft. We find ourselves in a current financial environment that is testing professional money managers to determine how to weight their portfolios. At the crux of the issue is the 10 Year U.S. Treasury note, the bellwether debt indicator on bond yields.

The yield on the 10 Tear advanced to a new 2018 peak just above 2.96 percent on Friday — its highest since January 2014. As a result, the U.S. Dollar gained against other major currencies. Higher U.S. bond yields will attract foreign investment, thus increasing the need for dollars. According to Peter Tchir, head of macro strategy at Academy Securities Inc. “Moving above 3 percent though will be tough, as there are resistance points around 3.05 percent. This rise in the long-end yields should take some more pressure off the curve-flattening trend.”

The yield curve expresses the risk versus return nature of debt instruments like notes and bonds. One would expect that yields or returns on shorter issues like the U.S. Treasure 2 Year note would be lower than that of a longer term note like the U.S. 10 Year Note or the U.S. 30 Year bond.  Exposure to the marketplace is a risk. The longer you are in the market, the more you are at investment risk. It makes sense that investors should be compensated more for holding longer term debt securities.

So what does this have to do the stocks you currently own? Modern portfolio theory says it has a lot to do. Bond yields are a leading indicator of future stock prices. As the yields of treasury notes and bonds go, it becomes more competitive with rates of return in the stock market. Think about it like this. When was the last time you were really excited about putting your money in a certificate of deposit (CD)? I’m thinking circa late 70’s, early 80’s era of stagflation. Also remember that when comparing treasury bonds to equities, the bonds, as well as CD’s, are risk free, backed by the good faith of the U.S. government.

Société Générale estimates, assuming the risk premium remains unchanged, the S&P 500 should fall to 2,509 when the 10-year yield rises to 3.00%, as the chart below shows.

Several other events are also correlated to these figures. Yields will rise as the Treasury increases debt sales to finance expanding government deficits and as the Federal Reserve trims its bond portfolio. The central bank is also signaling further interest-rate increases through at least the end of 2018. On a more basic, consumer consumption note, higher yields will generally cost you more to finance, when you buy things like houses and cars. Most consumer debt is tied to these benchmark government yields. As the higher they go, the more you will pay in interest, and hence the more you will spend in total on a financed house or car.

 

 

About John Thomas

John Patrick Thomas is a four-time cancer survivor who lives with his family in South Florida. John attended Gettysburg College and The American University before embarking on an entrepreneurial career on Wall Street. He turned to the teaching profession after his life-threatening bout with bone cancer. John has recently written a #1 Amazon Cancer Bestselling book entitled, “A Call to Faith, the Journey of a Cancer Survivor.” He has appeared in publications such as The New York Times, The Wall St. Journal, The Washington Post, Memorial Sloan-Kettering Cancer Center publications, and was featured in new DayStar network series, “Impact with Pastor Dave.” He has traveled as a missionary and may be one of the few people that tell you cancer was the best thing to ever happen to him. You’ll have to ask him why.

One comment

  1. You loose (haha–of course I meant lose) your credibility when your grammar fails in the headline. How do I know you know what you’re writing about, when the headline is nonsensical?
    “How Treasury Bonds Affect Your Stock Portfolio”
    Much better, no?

    Unfortunately, the body doesn’t quite redeem the headline.
    “The yield on the 10 Tear advanced to a new 2018 peak just above 2.96 percent on Friday…”
    “One would expect that yields or returns on shorter issues like the U.S. Treasure 2 Year note…”
    But kudos for spelling “Société Générale” correctly!

    You’re welcome. I’m available to proofread on contract if you’d like.
    Jim Sterling

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