Will Yields Break on Through to the Other Side?

By Charlie Bilello

Bond yields appear to be at a crossroads.

At 2.83%, the 10-Year Treasury yield is now at its highest level in over four years. It is also at the upper end of a downtrend channel that has been in place since the mid-1980s.

Source: Pension Partners, Stockcharts.com

The question all investors are asking: will yields finally break on through to the other side?

If economic growth and inflation are going to increase as expected from here, a continued rise in yields would seem likely.

But the better question perhaps is whether investors should welcome or fear such an outcome.

In the past 30 years, there have been a number of inflection points in the chart above where yields failed to break higher. These include:

  • October 1987: preceding the stock market crash.
  • May 1990: preceding the 1990 bear market (20% S&P decline) and 1990-1991 recession.
  • January 2000: preceding the bear market which began in March 2000 (51% S&P decline) and 2001 recession.
  • June 2007: preceding the bear market which began in October 2007 (57% S&P decline) and 2007-2009 recession.

At the opposite end of the spectrum, there have been a number of inflection points where yields failed to break lower. These include:

  • October 1998: coinciding with S&P 500 bottom and run-up until March 2000 peak.
  • June 2003: occurring shortly after the Bear Market low, S&P would continue to run-up until October 2007.
  • December 2008: preceding the equity market low in March 2009 and start of the new expansion in June 2009.
  • July 2012: preceding a continued run-up in equities over the next 5+ years.

From these examples it appears that the failure in yields to push higher at inflection points was a more ominous sign than had they continued higher. For such a failure preceded economic weakness in 1990, 2000, and 2007 and a market crash in 1987.

While the recent decline in the equity markets is being blamed in large part on the rise in yields, there is little evidence historically showing that rising rates are necessarily bad for equities. In fact, just the opposite appears to be the case, with the S&P 500 actually outperforming on average in years in which 10-year Treasury yields have risen (see full post on this topic here).

Source Data: Bloomberg, Pension Partners

To be sure, there have been times when equities have fallen in a rising rate environment, most notably during the 1973-74 recessionary bear market when rising inflation was of great concern. But in the past 30 years, it has more often been the opposite outcome (sharply falling rates) that signaled problems for equities.

So perhaps yields breaking on through to the other side wouldn’t be the worst thing after all.

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