With yields on benchmark 10-year Treasuries back above 2.0% and ongoing concerns of an eventual “tapering” of the Fed’s quantitative easing program, equities and stock exchange traded funds investors are beginning to make a move.
Some observers are arguing that the rally in defensive areas, such as consumer staples, health care and dividend stocks, is getting stale, and underperforming cyclical sectors, like energy, is set to outperform, reports Jeff Cox for CNBC.
“Rising bond yields could take some of the steam from dividend yield plays, especially in the staples and health-care areas,” Tobias Levkovich, Citigroup’s chief U.S. equity strategist, said in the article. “Competitive yields might mean that the dividend fascination gets dimmed somewhat, and several groups suffered when 10-year yields climbed in the past.”
“Since 2000, rising bond yields have mostly been associated with rising equity markets,” according to a Deustche Bank research note, Business Insider reports. “Even sharp rises in bond yields have overwhelmingly coincided with positive equity returns (88% of instances).”
Rising interest rates are also a good sign that the overall economy is improving. The Institute for Supply Management, though, believes that growth remains fragile.
“It reflects an improving outlook for economic growth and less risk of deflation,” Jeffrey N. Kleintop, chief market strategist at LPL Financial, said in a New York Times article. Both are positives for equity investors. Additionally, “it results in losses for bonds,” he added, which may signal investors to sell bonds and move into stocks.
However, over the short-term, the stock market could contract as interest rates rise. Specifically, the future discounted cash flow from a company could drop, which will cause investors to lower the price of the company’s stock. Rising interest rates would also affect consumer business psychology since both would cut back spending, which would affect earnings and stock prices.
“We believe the S&P 500 is undergoing a normal and healthy digestion of gains that will likely end up as loud noise [a decline of 1 percent to 4.9 percent]but not something worse,” Sam Stovall, chief equity strategist at S&P Capital IQ, said.
Investors, though, should become concerned if rising rates were a response to rising inflation as the Fed would start cutting back its efforts to stimulate the economy.
“Strong economic growth, with little inflation, makes the 1994 comparison with the current situation relevant,” Deutsche Bank strategist Francesco Curto said in an earlier report.
For now, market observers can use the 6% marker as a red signal – Doug Ramsey, chief investment officer at Leuthold Group, found that the negatives outweighed the positive once 10-year Treasuries yielded 6% or higher.
For more information on the broader stock markets, visit our S&P 500 category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.