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What’s so special about 5%?
That’s the question for would-be stock-market bulls, as a continued bond-market rout sends Treasury yields — which move opposite to price — soaring to 16-year highs and on Monday saw the 10-year yield
BX:TMUBMUSD10Y
top the 5% threshold. The quick, large rise in yields is forcing investors to recalibrate their expectations — and allocations between financial assets.
See: Stock-market investors face reality of 5% Treasury yields. Here’s what’s next.
It’s worth noting that over the past couple of decades, pushes above the 5% level for the 10-year have been short-lived — falling back below that level just before or during recessions, Andrew Greenebaum of Jefferies said in a Saturday note — an observation that isn’t exactly comforting.
And for now, “regardless of the possible implications for the real economy, the trade-off between stocks and bonds continues to be the most significant driver for equities broadly,” he wrote.
Unfortunately for the bulls, history doesn’t paint a pretty picture around a 5% yield for the 10-year note when stocks sport an earning yield near current levels, Jefferies found (see table below).
The table depicts the forward 12-month price performance of the S&P 500 (SPX) for every day since late 1962, organized by trailing 12-month EPS yield for the SPX and the corresponding 10-year Treasury yield on that day. The averages are based on days when the respective yield was greater than the preceding cell but below the labeled value.
Jefferies
The table breaks down the forward performance of the S&P 500
SPX
based on the “harmony” of the 10-year Treasury yield and the S&P 500’s trailing 12-month earnings yield. Jefferies said it used the backward-looking earnings figure because it allowed them to look back to performance since 1962.
There were a pair of “shocking” revelations, Greenebaum said. One is that S&P 500 returns have frequently been strong when the 10-year yield is high.
The other, less comforting observation is that when the S&P 500 is barely outyielding the 10-year note, performance over the next 12 months isn’t so hot. Unfortunately, with the S&P 500 trailing 12-month yield just over 5% and the 10-year Treasury yield just under 5%, “that’s exactly where we are right now,” Greenbaum observed in the Saturday note.
The circle on the table highlights the average 12-month forward performance for the current data, showing a range of plus 0.31% to 3.24%. That “isn’t too cheerful” compared with a roughly 5% Treasury coupon, Greenebaum noted.
So where were the best returns? As the table shows, when the Fed was pursuing a zero-interest rate policy (no surprise there) and, more interestingly, when the 10-year yield was much higher, showing no real relationship to the earnings yield, he noted.
Check out: Fed says bond market’s term premium is the reason behind rise in Treasury yields. Why investors should take it with a dose of caution.
Read the full article here