Investors Are Hoping That a Robust Economy in the United States Would Protect Equities From a Jump in Yields

With Treasury yields on the rise, confident investors are placing their bets on the idea that a strong U.S. economy and decreasing inflation will protect stocks from any adverse consequences this time.

Increasing yields is commonly seen as a challenge for stocks as it makes bonds more attractive than equities and raises the cost of capital. The S&P 500 index experienced a significant drop of 19.4% in 2022 due to a sudden increase in yields caused by the Federal Reserve’s decision to raise interest rates as a precaution against rising inflation.

The market also faced instability when yields reached their highest point in 16 years last year. However, stocks quickly rebounded once the situation reversed.

Treasury Bond Yields Are Rising

Once again, the strong connection between the two was apparent on Tuesday when unexpectedly high consumer price data for January weakened the argument for immediate Federal Reserve rate reductions, causing Treasury yields to surge.

The benchmark 10-year yield, which has an inverse relationship with bond prices, reached a peak of 4.297%, marking its highest level in the past ten weeks. The S&P 500 ended the day with a decline of 1.36%, despite being close to the all-time highs reached earlier this week.

Several investors, though, believe that stocks are currently better equipped to handle another increase in yields. One factor is the robustness of the U.S. economy, which has surpassed expectations in the midst of rising interest rates. This has alleviated worries about the potential negative impact of tighter monetary policies on economic growth.

Despite investors tempering their expectations for the extent of the Federal Reserve’s interest rate cuts, it is widely anticipated that the cooling inflation will prompt policymakers at the U.S. central bank to proceed with rate reductions in the coming months. The 12-month consumer price increase has eased to 3.1%, down from its highest level in 40 years at 9.1% in June 2022.

“Rates are elevated, but that indicates that the economy is in a rather favorable condition,” expressed Michael Purves, the leader of Tallbacken Capital Advisors. Meanwhile, inflation is significantly less alarming than it was previously.

Purves anticipates that the 10-year Treasury yield will gradually increase, reaching a range of 4.25% to 4.75%. Meanwhile, he predicts that equities will continue to rise, albeit at a more moderate pace. Last year, the yield reached a peak of slightly above 5%.

Positive Earnings

Investors’ optimistic sentiment was evident in BofA’s most recent survey of fund managers, revealing that investments in global stocks have reached their highest level in two years. Confidence in the economy has reached its peak since the beginning of 2022.

Numerous investors have also found solace in an earnings season that thus far has surpassed expectations. After receiving data from approximately two-thirds of companies, it is now projected that fourth-quarter earnings growth for the S&P 500 will reach 9.2%. This is nearly double the growth forecast of 4.7% that was made on January 1st, as reported by LSEG data on Friday.

“Earnings season was rather impressive,” commented Wei Li, the global chief investment strategist at BlackRock (NYSE:BLK). “Throughout the entire equity market, numerous sectors experienced favorable earnings, which overshadowed the impact of rate repricing.”

According to her, the recent gradual increase in yields has given the market more time to process and understand them.

“Sometimes, the importance of speed outweighs the significance of levels,” she stated.

Investors might consider selling if yields continue to rise. The S&P 500 has experienced a remarkable surge of 20% since its October lows, primarily driven by the prominent “Magnificent Seven” – the dominant growth and technology stocks that hold significant influence over the index.

Bank stocks have taken a significant blow due to the anticipation that interest rates will remain elevated for an extended period. The KBW Regional Banking index has plummeted by almost 12.5% due to concerns regarding the industry’s vulnerability to distressed U.S. commercial real estate. The market experienced a decline of 4.49% on Tuesday.

Lara Castleton, the U.S. head of portfolio construction and strategy at Janus Henderson Investors, has become increasingly wary of the market rally as stocks have continued to rise in recent weeks.

However, she is confident that stocks will receive backing from substantial cash holdings, which could provide investors with the means to purchase stocks during market declines. As of February 7th, data from the Investment Company Institute reveals that the assets of money market funds reached an impressive $6.02 trillion.

“There is an abundance of funds patiently awaiting an optimal moment to make a purchase,” she remarked.