Interest rates rose this week as investors believed more in the economic recovery. One problem: stocks can get sick to grow.
The yield on 10-year Treasury debt ended at 0.91% on Friday to 1.1% by Monday. With the Senate Democrats winning, the likelihood has increased that Congress will spend at least a few hundred billion dollars more to run the economy. This means better growth and slightly higher inflation may emerge. Bond yields reflect those expectations.
“Cause they [rates] JD Kinahan, chief market strategist at TD Ameritrade, said spiking is in anticipation of the stimulus Baron’s. “Are We Leading to an Inflationary Scenario?”
A gradual move in interest rates is usually seen as a sign of optimism, but a sudden increase in yields or one not yet priced to reflect in the market – can be problematic for the stock. High interest rate pressures are stock valuations because they erode the value of future corporate profits.
And the valuation is currently high, a reflection of how historically interest rates have fallen. The S & P 500 stock has an average of about 15 times longer than the average for the coming year, 23 times less than the earnings for the coming year.
“Even if US 10-year bond yields are now over 1%, that may be enough to hit the tipping point where the equity market bubble erupts,” Albert Edwards, global strategist wrote
The Federal Reserve is investing money in the bond market to keep prices high and interest rates low to stimulate the economy, but Edwards, known for his perennial recessionary views, said the Fed would also help stop the bleeding. May not be enabled.
With the increase in yields, investors are paying a higher price for the shares.
Friday ended 3.3% above Monday’s closing level.
The assumptions, while magnified according to some, are arguably not at nosebleed levels. At current prices, the S&P 500’s equity-risk premium-earnings index yields more than the average stock that investors can get from securing 10-year Treasury debt – at 3.27%. Premiums often exceed 3%, suggesting prices are not out of control.
At the same time, however, it rarely falls below 3%, and when this happens, stocks often fall. Edwards says in his report that data suggest bonds are set to increase yields. If earnings on shares do not increase, it means a risky premium.
He said yields rise and fall on the 10-year Treasury Debt for manufacturing at the Institute for Supply Management Purchasing Managers Index, or PMI. And this measure recently reached almost the highest level of 60, the highest level since 1995. The correlation should be for a 1.2 percentage-point increase in 10-year yields.
If the rate rises sharply, stock valuations will increase without an increase in earnings that a higher PMI and a stronger economy would typically bring.
Write Yakub Sonnashine @ Yakub Sonshine. Com