Investors are probably tired of hearing warnings that bond exchange traded funds could get dinged by rising interest rates. Higher bond yields will have a significant effect on stock ETFs as well.
“While a disappointing employment report tempered fears of an imminent bond market meltdown, many equity investors are still concerned over the potential impact of rising rates on stocks,” said Russ Koesterich, iShares Global Chief Investment Strategist, in a recent note.
Treasury yields have been trending lower since mid-March following a brief spike. Bond prices and yields move in opposite directions.
The main question for investors is whether the three-decade rally in U.S. government debt can continue. [ETF Moves to Make if Interest Rates Rise]
“Putting the current yield environment in context, even after removing the 1970s and early 1980s— a period of unusually high nominal yields— the long-term average yield for the 10-year note is still 5.25%, more than twice today’s level,” said the iShares strategist.
Historically, stocks have not been hurt when rates rise from “the absurdly low to merely low,” according to Koesterich.
Of course, stock ETFs’ reaction to rising rates will depend on exactly why Treasury yields are moving higher. Bonds are influenced by numerous factors, including the health of the economy, inflation expectations, Federal Reserve bond buying and views on the U.S. debt level.
“When interest rates are rising due to heightened inflation expectations, stock multiples tend to contract. However, when real rates are rising, particularly in the context of a strengthening economy, multiples have not been hurt,” Koesterich noted.
Today, weak growth is the greater threat to equity valuations, he warns. “While higher real yields probably won’t hurt multiples, earnings could be dampened if they rise high enough. However, given the fact that nominal yields are still close to a record low, and real yields remain negative, a modest backup in yields is not a major threat to stocks.”
In fact, Koesterich would be more concerned about stocks if rates fell further, a scenario that would probably be accompanied by another recession scare.
Yields on the 10-year note have been hovering around 2%. The iShares Barclays 20+ Year Treasury Bond (NYSEArca: TLT) was down 3.1% year to date as of April 16 but gained 5% for the trailing month, according to Morningstar.