Stock-market Gains Are Challenged by Soaring Treasury Yields

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The recent surge in long-term interest rates this month is fueling concerns among investors regarding the future trajectory of the stock market.

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Treasury yields reached new highs for 2024 in the past week following fresh data indicating persistent inflation. At the onset of the year, Wall Street traders anticipated the Federal Reserve to reduce rates by as much as six times. However, the current market sentiment reflects expectations for just one rate cut. The yield on the 10-year Treasury note, which moves inversely to bond prices, has risen by nearly a percentage point since its lows in February, settling at 4.668% on Friday.

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The uptick in yields is raising fears that further stock gains may be impeded, particularly as stocks are relatively expensive compared to corporate earnings. In 2022, rising yields led to significant stock declines, diminishing the extra return investors typically receive for holding stocks over bonds and diminishing the present value attributed to companies’ future profits by Wall Street.

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The tensions were evident when stocks fell and yields surged on Thursday following weaker-than-expected U.S. growth data alongside stronger-than-anticipated inflation indicators. However, markets rebounded on Friday, buoyed by robust earnings reports from companies like Google parent Alphabet and an expected reading of the Fed’s preferred inflation metric.

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Rick Rieder, chief investment officer of global fixed income at BlackRock, noted a drastic shift in market sentiment from earlier expectations of multiple rate cuts to a more cautious approach, emphasizing the market's hypersensitivity to incoming information.

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Investors eagerly await insights into rate prospects from Fed Chairman Jerome Powell at the conclusion of the central bank’s meeting on Wednesday. Additionally, attention will be on Friday’s jobs report and the Treasury Department's quarterly borrowing plan release, shedding light on the government’s borrowing strategy to address its budget deficit.

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Despite the strong economy boosting corporate earnings, the recent climb in yields has stretched valuations, with companies in the S&P 500 trading at about 24 times their trailing 12-month earnings, well above the 10-year average of roughly 20 times. The combination of slowing growth and higher-than-expected inflation signals a potentially gloomier outlook.

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David Kelly, chief global strategist at J.P. Morgan Asset Management, acknowledges the challenges posed by high rates, particularly for speculative segments of the market and tech companies with lofty valuations. He foresees vulnerabilities in assets like cryptocurrencies, gold, and growth stocks, which have benefited from low rates.

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Despite expectations for yields to retreat by December, volatility and potential spikes in yields are anticipated in the near term. While Rieder believes rates will decrease by year-end, caution prevails amidst significant uncertainty in the market.

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