Bonds were shunned by many investors because the lowest interest rates made them unattractive relative to stocks. On Thursday, the bond market may have gained the upper hand in the eyes of some investors.
The 10-year government bond yield rose 9 basis points to a high of above 1.49% on Thursday, reaching its highest level since February 2020. The peak brought the benchmark interest rate above the S&P 500 dividend yield, according to FactSet calculations based on payments from the past 12 months.
The milestone is important for large investors who track the valuation of all assets, as Treasury bills are considered the risk-free rate, meaning that stocks have lost their premium over bonds, yet are riskier securities. Thursday’s move heightened fears that a stock-to-bond rotation would accelerate, as higher interest rates make high-flying stocks less attractive.
Bond yields have risen sharply this month, with 10-year yields up more than 35 basis points. The advance was prompted by expectations for stronger economic growth and a pick-up in inflation.
“The interest rate story since March 2020 has played a significant role in raising risky assets across various asset classes with optimism ahead of the actual broader economic recovery,” said Gregory Faranello, chief of US interest rate trading at AmeriVet Securities. “A sustained rise in US long-term interest rates will at some point create a value proposition, especially if we have the opposite of 2020, with returns lowering risk assets now and broader financial conditions tighter.”
Many strategists cited rising yields as a culprit for the weakness in technology stocks and increased volatility in the broader market. Higher interest rates could hit the growth-oriented technology sector particularly hard, as they have benefited from easy borrowing.
Yields continued to rise even after Federal Reserve Chairman Jerome Powell downplayed the risk of inflation and said it could take three years to consistently achieve the central bank’s goal. He said inflation was still “soft” and the central bank has the tools to fight it if it gets hot.
“The rise in interest rates is mainly driven by rising inflation expectations,” said Joseph Kalish, chief global macro strategist at Ned David Research, in a note. “More recently, expectations of better economic growth on the road have driven up real revenues and higher inflation and liquidity premiums.”
Dividend yield, calculated as annual payouts divided by stock prices, has fallen as the stock market climbed to new highs and yet companies have not raised much dividends during the pandemic.
According to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, dividends from S&P 500 fell $ 42.5 billion in the second quarter of 2020, followed by another $ 2.3 billion in the third quarter. Payouts increased by $ 9.5 billion in the fourth quarter last year as companies survived the worst of the health crisis.
If Corporate America could continue to increase its dividends, which increased its overall dividend yield, the stock market could regain an edge over bonds.
To be sure, dividends have become less important in recent years as high-tech stocks that largely avoid payouts have led the market.
And stocks still offer a premium over bonds when the income is taken into account. According to FactSet, S&P 500 members will earn $ 172.26 per share this year, analysts estimate. That amount divided by the current value of the S&P 500 gives it what is known as a 4.4% earnings yield, which is another way investors value assets against each other.
– CNBC’s Nate Rattner contributed to this article.
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