Rising yields caused recent stock market turbulence as the 10-year Treasury yield climbed by 50 bps in a month to 1.5% and tapped 1.61% on February 25.

Rising yields, particularly 10-year Treasury yield is a potential risk to the stock bull market which we have been flagging for some time.

Why are rising yields a risk to investors? 

10-year Treasury yield is a global yardstick for interest rates on everything from loans to corporate bonds. So rising yields raises the cost of servicing debt, which is a headwind on consumption business investments and corporate profitability. 

Rising yields also increase the opportunity cost for investors in stocks, precious metals, the property market, and other non-fixed income investments.

Rising Yields
S&P 500 returns 2019

“Rising yields, particularly 10-year Treasury yield is a potential risk to the stock bull market which we have been flagging for some time”

WEALTH TRAINING COMPANY

In other words, at some level, rising yields are a risk to the current stock bull market and other asset valuations

So, the threshold point is 2.1% for the 10-year Treasury yield, according to US investment bank Goldman Sachs. When rising yields exceed the 2.1% red-line then investors should buckle-up for the anticipated volatility ahead. 

In the history of rising yields, the 2.1% threshold for the 10-year Treasury yield is relatively low

The 10 Year Treasury Rate chart over the last 50 years shows a long-term decline in yields. In the early 80s yields peaked at nearly 15%, in the 90s yields fluctuated from 8.95% to a low of 4.4% and in the last decade, the 10 Year yields fell to their lowest level of 2.13% in December 2008 during the last subprime financial crisis and Great recession.

Rising Yields - investors buckle up

“when rising yields exceed the 2.1% red-line then investors should buckle-up for the anticipated volatility ahead

WEALTH TRAINING COMPANY

Global investors perceive the 10-year Treasury as a safe-haven asset due to the USD privilege of being the world’s reserve currency and the Federal Reserve being able to create USD to finance the US public deficit. But notice how the 10-year Treasury has been in a steep decline since the mid-80s. Nevertheless, the long-term average yield for the 10-year Treasury is 4.38%, which is way higher than Goldman’s red line of 2.1%. 

What is causing the 10-year Treasury rising yields, which is now moving on traders’/ investors’ radar? 

Treasury yields are determined by the supply of treasuries and their demand, bearing in mind that the price of a treasury is inversely related to its yields. 

“10-year Treasury yields tend to rise with higher inflation expectations” – Wealth Training Company

As the price of the 10-year Treasury falls on the bond market, due to say a lack of demand, then its corresponding yields rise

So, 7 year auction recently went ahead, February 28, but here comes the problem, demand for the recent treasury auction was dismal, to say the least. So, pundits believe the treasury auction failed due to attract buyers because of rising expectations of inflation. Rising inflation makes fixed-income investments less attractive, bearing in mind that a bond is a promise to receive the invested amount back on the maturity date plus the yields. So, 10-year Treasury yields tend to rise with higher inflation expectations.

The recent USD depreciation of 12 % could also be another reason for waning foreign investor enthusiasm for treasuries. Think about it. Investing in a treasury with yields of less than 2%, where the USD dollar depreciates 12% in one year is like slow walking up a fast downward-moving escalator. 

For treasuries to be attractive to foreign investors the USD decline has to halt or yields have to rise a lot higher to compensate for a depreciating USD. 

Which companies would be most vulnerable to rising yields? 

In other words, which companies would be most adversely impacted by the rising cost of serving their debts. Companies operating on tight profit margins and declining revenues would be the worst impacted by rising yields. 

As I have noted from the pandemic and economic shutdowns, not all companies are the same.

In fact, what has emerged is a dualistic stock market where those companies that have embraced digitalization, or assisted in the digitalization of cybersecurity, have seen their revenues boom in the pandemic.

Meanwhile, companies where digitalization was less possible experienced crushing revenues and profits during the economic shutdown.

“the pandemic lockdowns highlighted a dualistic stock market, where the out-performers did even better in the post-pandemic economy and those that lagged did even worse”
Wealth Training Company

In short, companies with at least $50 million in revenues were able to expand their revenue during the lockdowns by digitalizing their operations performed the best, despite their negative earnings. “Those with negative earnings and declining revenues in 2020 returned a median of -18% last year. In contrast, stocks with negative earnings and growing revenues returned +51%,” wrote Goldman Sachs. 

The chart on the left shows two different types of stocks with negative earnings.

Notice how the best-performing stocks in 2020 are those with high revenue growth but negative earning. But if companies experienced negative earnings and declining revenue these stocks underperformed. As investors, this should not surprise us, that stocks with revenue growth outperform and are likely to continue outperforming the wider indices even in an environment of rising yields. 

The pandemic lockdowns highlighted a dualistic stock market, where the out-performers did even better in the post-pandemic economy and those that lagged did even worse. 

The post-pandemic economic recovery, whatever shape it may take, is likely to cause rising yields as capital flows from safe haven assets to more speculative cyclical investments

With the US growing at its fasts pace on record, the S&P 500 EPS in 2021 is anticipated to grow by 27% and be 10% higher than pre-pandemic 2019., according to Goldman.

If the US investment bank’s assessment is accurate, then the bank believes that a 14% raise this year to our year-end price target of 4300 despite a flat P/E multiple. 

So, in short, the bulls could be running on firm ground as the economy emerges from the pandemic. Household savings are at an all-time high, corporates are also cashed up and ready to invest, but it is rising yields that could also tame the bulls going forward.

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