The Tell: Here are 3 reasons why the stock market can survive rising bond yields in 2021

The Tell: Here are 3 reasons why the stock market can survive rising bond yields in 2021

2021-02-23 22:49:00

Rising government bond yields have contributed to a sell-off by the stock market pandemic high-fliers, but will likely not be enough to spoil the appeal of stocks over bonds in 2021, according to one analyst.

US equity investors "have focused on the recent rise in 10-year government bond yields over the past week, going all the way back to mid-February 2020," wrote Lori Calvasina, head of US equity strategy at RBC Capital Markets. in a Tuesday note. Yields and bond prices have an inverse relationship.

The yield on 10-year Treasury bills

comes from the largest rise in six weeks, which is behind a relapse led by technology-focused stocks that had benefited the most from the stay-at-home dynamics triggered by the COVID-19 pandemic.

Related: Can the bull market in stocks survive rising inflation and bond yields? This is what history says

The relationship was seen in reverse on Tuesday as interest rate hike eased following testimony from Federal Reserve Chairman Jerome Powell, which allowed key benchmarks to wipe out or downsize significant losses. The technically demanding Nasdaq Composite

which led the way down, a loss of nearly 4% limited to 0.5% as revenues fell; the S&P 500
+ 0.13%

Eeked a profit to break a five-day loss streak, while the more cyclical-oriented Dow Jones Industrial Average
+ 0.05%

eliminates a loss of more than 360 points to finish slightly higher.

Meanwhile, Calvasina said a look at what stocks have to offer in terms of dividends and earnings yield relative to bonds, and a reminder of what sort of bond moves have caused problems for stocks, provides some reassurance that 2021 is unlikely to turn into a downside. , she said.

Dividend Yield

When it comes to dividend yield, RBC has measured the percentage of companies that continue to exceed yield on 10-year Treasury bonds. While that dropped from 64% to 51.5% at the beginning of the year, it is still within a range typically followed by a 17% gain for the S&P 500 over the next 12 months, she said.

Profit Yield

The S&P 500's earnings yield has also deteriorated, moving towards the lower end of the bandwidth since the end of the financial crisis. It is now near the 2017-18 level, but remains within a range followed by 9.3% average gain by the S&P 500 over the next 12 months, Calvasina said.

In other words, this analysis acknowledges the arguments for a short-term pullback in the S&P 500, but does not necessarily mean that investors should move to the exit in the longer term, ”she wrote.

Calvasina also highlighted a "key difference" between 2018, when the trade war threatened the US and the global economy, and now, when gross domestic product forecasts are rising rapidly.

Treasury yields and shares

Finally, what about the rise in the interest rate on Treasury bonds themselves? Finally, many market observers have argued that while returns remain low by historical standards, the magnitude of the rise may be of greatest concern to equities. Calvasina has broken down the relationship between interest rate movements and stock market performance in the chart below:

RBC Capital Markets

Calvasina said US stocks tend to struggle if 10-year yields rise more than 275 basis points or 2.75 percentage points. Hitting the low of 0.51%, a move of 275 basis points would bring returns to around 3.26%. The 10-year ended Tuesday at 1.363%.

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