Why Rising Bond Yields Pose a MAJOR Problem for Stocks
Posted February 12, 2021
As I mentioned yesterday, my biggest concern with the stock market today is the rise in U.S. Treasury yields. As a quick review, the yield on every U.S. Treasury bond over 10 years in duration has been rising.
The yield on the 10-year U.S. Treasury has more than doubled since August. The yields on the 20-year and 30-year U.S. Treasuries are not far behind.
Bond investing is a very complicated thing. So, the simplest interpretation I can offer about these moves is that the bond market is saying, “I don’t want ANYTHING to do with long-term U.S. debt. If you want me to fund your outrageous debt levels, you’re going to have to pay me a LOT more in yield.”
This is an extremely bad situation for stocks.
Because the yield on U.S. Treasuries, particularly the 10-year U.S. Treasury represents the “risk free” rate of return for the global financial system. This means that all risk assets, including stocks, are priced based on where these yields are trading.
This method of stock investing is called the Fed Model, and our current Fed Chair Jerome Powell is a BIG believer in it.
Proof is in the Pictures
The chart below shows the yield on the 10-year U.S. Treasury compared to an inverted S&P 500 (meaning when the stock market rises, the blue line falls). The relationship, while not perfect (for the obvious reasons that market conditions can change dramatically in the intermediate term), is a solid one.
When U.S. Treasury yields are rising, stocks begin to become less attractive as an asset class. This is particularly true when you consider that the U.S. now has over $27 trillion in debt and a debt-to-GDP ratio of 130%.
If this situation continues, it will burst the U.S. stock market bubble.
If you don’t believe me, take a look at the charts below. In 2018, the yield on the 10-year U.S. Treasury bond rose so high it broke out of its long-term downtrend.
That’s when stocks did this:
As I write this, the yield on the 10-year U.S. Treasury is on the verge of doing something similar. At its current pace the yield on the U.S. Treasury will break its downtrend sometime in May.
When that happens, the fuse is lit on the stock market.
So, while stocks continue to churn higher, keep an eye on U.S. Treasury yields. Once we get closer to that red line, it will be time to start keeping an eye on the exits.
Editor, Money & Crisis