As Rates Spring Back, Is a Weak Summer for Stocks Ahead?

photo by Éole

photo by Éole

Government bond yields have moved sharply higher in 2009—although they remain at historically low levels. After reaching a low of 2.05% on December 30, 2008 the yield on the 10-year Treasury note climbed to a high of 3.74% last week, reversing the decline in yields that took place during the fourth quarter. The price of the 10-year T-note, which moves in the opposite direction of the yield, has plunged, resulting in about a 25% loss over the same period. Late last year, we recommended avoiding Treasuries and wrote about a developing bubble in them as investors sought safe haven from the financial crisis. Now that the direction of government interest rates has clearly turned around, what does the rise in Treasury yields mean for the economy and markets?

Time To Get Healed

The healing process underway in the United States is driven in part by low interest rates that contribute to low mortgage rates, low cost of capital for businesses, and the low cost of government debt used to finance stimulative policy actions. Fortunately, mortgage rates and corporate bond yields have not risen significantly; credit spreads have contracted, allowing these important rates to remain largely unchanged. In fact, Baa-rated corporate bond yields are about that same as they were on December 30, 2008 when Treasury yields were at their low, and the average rate on a conventional 30-year fixed rate mortgage remains at about 5%. Rising interest rates are common near the end of recessions, as in fact happened with each of the past five recessions. As you see the magnitude of the rate bounce is often related to the length and severity of the recession. The largest rise was in 1983 following the back-to-back recessions and inflation spiral of the late 1970s and early 1980s. The rise in rates is usually a sign that markets are beginning to broadly expect the recession is coming to an end and a return to growth is on the way.

The Big Bounce

The bounce in yields this year has been bigger than average. However, given the severity of the recession and the fact that rates fell to just 2%, the sharp rise is not surprising. Based on the path of prior yield bounces, when after 90 trading days, the yield bounce has typically peaked, the current episode may have now run its course. Chart 2 shows the current bounce in yield on the 10-year T-note since the low on December 30, 2008 relative to the average bounce of the prior fi ve recessions. In the past 20 trading days,the yield has broken away from the average to total a rise of about 170 basis points since the low, compared to the average of about 100 bps by this point.

On average, stocks have posted slight gains in the past during the bounce in yield. The average performance of the S&P 500 along with the change in yield on the 10-year T-note over the bounces of the past five recessions. Returns average only a few percentage points over the 90 days following the low in yield. Returns were modest in all cases.

The bounce in yield since December 30, 2008 has coincided with a wide range for the stock market, yet the S&P 500 has posted a net gain similar to the historical average for this point in the bounce. The S&P 500 fell 25% during the two months that followed the low point in yield, followed by a rebound that has resulted in a modest gain since the low point in yield.

Will It Rise?

While the rise in Treasury yields is a normal and healthy part of the healing process in the economy and markets, a further rise in the 10-year T-note yield over 4% this summer may act as a negative factor. The modest returns for stocks during similar yield bounces in the past highlight the fact that the bounce in yield does not merely signal better economic prospects—if that were true stocks would have posted more powerful gains. Rising yields provide less stimulus to the economy and may refl ect the impact of the rise in the budget deficit as tax revenues fall while government spending rises. Above 3.7% on the 10-year T-note appears to be the range where mortgage and corporate bond yields began to rise in tandem with Treasuries, weighing on performance for both bonds and stocks. Fear that yields may continue to trend upward may keep a lid on the stock market.

IMPORTANT DISCLOSURES

  • The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
  • Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity.Stock investing involves risk including loss of principal Past performance is not a guarantee of future results. Investing in alternative investment may not be suitable for all investors and involve special risks such as risk associated with leveraging the investment, potential adverse market forces, regulatory changes, potential liquidity. There is no assurance that the investment objective will be attained. Small-cap stocks may be subject to higher degree of risk than more established companies’ securities. The illiquidity of the small-cap market may adversely affect the value of these investments.
  • Alternative investment mutual fund strategies are subject to increased risk due to the use of derivatives and/or futures.
Related Posts with Thumbnails
Reports

Get the Money Dominating Toolkit

  • 6 Tools to Get Your Money Back on Track
  • The Ultimate Goal Achiever Workbook
  • 2 Free Chapters to my Best Selling Book
  • 21 Days to Destroy Your Bad Habits Worksheet

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>