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Sunday, Oct 01, 2023

The stock market sure is acting strangely

The stock market sure is acting strangely

Wall Street is having a topsy-turvy moment. Long-term Treasury yields have shot up dramatically, and investors in stocks are cheering the bond market's big moves. That doesn't happen often. So what gives?

Rising rates are supposed to be a bad sign for stocks. In theory, higher yields for the 10-year US Treasury should make it more expensive to get mortgages and other types of consumer and business loans.

Spiking bond yields are also often associated with higher inflation — a big problem for consumers lately — and they are rising now amid concerns that the Federal Reserve will jack up short-term interest rates to keep surging prices in check. That's also not a welcome sign for stocks.

Granted, rates are still historically low, with the 10-year currently yielding only about 1.69%. That's a reason why Peter Wilson, global fixed income strategist with the Wells Fargo Investment Institute, recently called the relationship between yields and high inflation an "odd couple."

But look at how far and how quickly rates have risen in a short period of time. The 10-year yield is up from 1.51% last Friday and was a mere 0.92% at the end of 2020. That means bond yields have shot up more than 10% in just a few days and 80% in a little more than a year.

It appears that investors don't expect bond yields to climb much higher from current levels though, even if the Fed raises short-term rates several times this year. That could fuel further gains in the stock market.

Yields may not have that much further to climb

Ameriprise chief market strategist David Joy wrote in a 2022 outlook report this week that bond yields "are expected to come under further upward pressure" this year. He believes they may top out around 2%, which would lead to "uninspiring returns" from Treasuries.

Few are predicting the type of shock that would lead bond yields to move substantially higher. Experts believe stocks still look more attractive than bonds because the global economy is expected to continue its recovery from the Covid-19 pandemic.

That should lead to stronger earnings — possibly accompanied by higher inflation.

"We expect interest rates to move modestly higher in 2022 based on near-term inflation expectations above historical trends and improving growth expectations once the impact of Covid-19 variants recede," said Lawrence Gillum, fixed income strategist for LPL Financial, in a 2022 preview report.

Gillum added that he expects the 10-year Treasury yield to end 2022 close to current levels, at 1.75% to 2%.

"An aging global demographic that needs income, higher global debt levels and an ongoing bull market in equities may keep interest rates from going much higher," Gillum wrote.

That desire for more income from investors who have retired or are preparing to as part of the so-called Great Resignation could push sectors of the stock market even higher, said JPMorgan Funds chief global strategist David Kelly in a 2022 preview report.

Kelly noted that international stocks in particular tend to pay dividends that yield much more than US bonds and stocks. He said alternative assets like real estate and commodities may do better than bonds, too.

"Entering the New Year, a good resolution would be to rebalance across domestic stocks, international stocks, fixed income and alternatives," Kelly wrote, "both to enhance long-term return prospects and to protect against the surprises that 2022 may bring."


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