Here are 3 reasons the stock market can survive rising bond yields in 2021


Rising Treasury yields have contributed to a sell-off from pandemic stock market high-flights, but it likely won’t be enough to ruin the appeal of stocks over bonds in 2021, according to one analyst.

Investors in US stocks “have focused on the recent surge in 10-year Treasury yields over the past week, going back to mid-February 2020 levels,” 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 10-year Treasury yield TMUBMUSD10Y,
1,345%
It is coming off its biggest rise in six weeks, which has been blamed for causing a pullback led by tech-oriented stocks that had benefited the most from the stay-at-home dynamic created by the COVID-19 pandemic.

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

The relationship was reversed Tuesday as rising yields eased on testimony from Federal Reserve Chairman Jerome Powell, allowing major benchmarks to erase or trim significant losses. The high-tech Nasdaq Composite COMP,
-0.50%,
which has led the way down, trimmed a loss of almost 4% to end with a 0.5% drop as yields declined; the S&P 500 SPX,
+ 0.13%
made a profit to break a five-day losing streak, while the more cycle-oriented Dow Jones Industrial Average DJIA,
+ 0.05%
He erased a loss of more than 360 points to finish slightly higher.

Meanwhile, Calvasina said that a look at what stocks offer in terms of dividend and earnings yield relative to bonds, as well as a reminder of what kinds of bond moves have spelled trouble for stocks, offers some reassurance of that 2021 is unlikely to turn into a year down, he said.

Dividend yield

When it comes to dividend yields, RBC measured the percentage of companies that continue to outperform 10-year Treasuries. While that has fallen to 51.5% from 64% 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, he said.

Earning performance

The earnings performance of the S&P 500 has also deteriorated, moving to the lower end of the range prevailing since the end of the financial crisis. It is now close to the level seen in 2017-18, but remains in a range that has been followed by 9.3% average gains for the S&P 500 over the next 12 months, Calvasina said.

“In other words, this analysis recognizes the case for a short-term pullback in the S&P 500, but does not necessarily indicate that longer-term investors should be heading out,” he wrote.

Calvasina also highlighted an “important difference” between 2018, when the trade war posed a threat to the economies of the United States and the world, and now, when forecasts for gross domestic product are rising rapidly.

Returns and treasury actions

Finally, what about the increase in Treasury yields? After all, many market watchers have argued that while returns are still low by historical standards, it’s the size of the rally that may be of most concern to stocks. Calvasina broke down the relationship between yield movements and stock market performance in the following table:

RBC Capital Markets

Calvasina said US equities have tended to struggle when the 10-year yield rises more than 275 basis points, or 2.75 percentage points. Coming out of its 0.51% low, a move of 275 basis points would bring the yield to around 3.26%. The 10-year term ended Tuesday at 1.363%.

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