Bruised market eyes Treasury yields to gauge stocks’ path
Investors are focusing on Treasury yields as a key factor in determining how stocks will fare the rest of the year, after a month in which equities notched their steepest losses since the coronavirus pandemic began.
The S&P 500 index(.SPX)posted its biggest monthly drop since March 2020 in September, while pulling back as much as 5% below its all-time high for the first time this year.
Stocks wobbled as yields on U.S. Treasuries shot to a three-month high, exacerbating worries in a market already unsettled by a nasty fight over the U.S. debt ceiling, the fate of a massive infrastructure spending bill and the meltdown of heavily indebted Chinese property developer China Evergrande Group. The S&P 500 is still up 16% this year.
“Investors are looking for a catalyst ... and the catalyst that they are currently focusing on is the direction of interest rates,” said Sam Stovall, chief investment strategist at CFRA.
Yields, which move inversely to bond prices, are rebounding from historically low levels and their recent climb is widely seen as a sign of economic strength.
Their rally follows the Federal Reserve’shawkish tilt at its monetary policy meeting last week. The central bank said it may begin tapering its $120 billion-a-month government bond buying program as soon as November and potentially begin raising rates next year, earlier than some were expecting.
Yetyield increases, such as the 27 basis point move logged by the 10-year benchmark note after the Fed meeting, could dim the allure of stocks. The 10-year yield was last around 1.47%, paring back gains toward the end of the week.
Stocks and bonds could take cues in the coming week from developments in Washington, where lawmakers continue to debate an infrastructure spending package, as well as next Friday’s monthly U.S. jobs report.
Among the indicators investors are using to gauge stocks’ future trajectory is the spread between the yields on two-year and 10-year Treasuries. Some view this as a barometer of whether the economy is slowing or overheating.
A spread of between zero and 150 basis points is a “sweet spot” for stocks, which has been consistent with an 11% annual return for the S&P 500, based on historical data, according to Ed Clissold, chief U.S. strategist at Ned Davis Research. The S&P 500 has averaged a 9.1% gain annually since 1945, according to CFRA’s Stovall.
That spread has recently widened and stood at around 120 basis points on Friday. When the spread exceeds 150 basis points, “that is when stocks tend to struggle,” Clissold said, historically equating to an annual S&P 500 return of 6%.
“Too steep of a curve implies that inflation is getting out of control and the Fed may have to tighten quickly,” Clissold said in a report this week.