Bond market warns of more pain for stocks as 10-year yield tops 3%

Rising bond yields could signal more trouble for equities, especially now that the 10-year Treasury yield is back above a critical level as selling in U.S. stocks intensified on Monday, many said. market technicians.

According to Nicholas Colas, co-founder of DataTrek Research, stocks are plunging because the yield on the 10-year Treasury note TMUBMUSD10Y,
3.038%
is on track to close above 3% on Monday for the first time since June.

The 3% level has served as an important stock demarcation line dating back to the stock sell-off that took place during the fourth quarter of 2018.

“It’s like clockwork,” Colas said in a phone interview with MarketWatch. “As yields approach 3%, markets get jittery. When they go above 3%, stocks go down.

This pattern has already happened once this year, as both Colas and BTIG market technician Jonathan Krinsky pointed out. The S&P 500 SPX index,
-2.23%
hit its lowest closing level of the year on June 16, just two days after the 10-year Treasury yield hit 3.48% – its highest level in more than a decade.

Years ago, stocks’ sensitivity to bond yields was rooted in the yield of the dividend investors earned simply for owning stocks, Colas explained. But over the past two decades, big companies have cut or even eliminated dividends as investors have begun to favor stocks with the best prospects for earnings growth.

The S&P 500 dividend yield now stands at around 1.5%, according to FactSet. But that doesn’t matter as much as the huge leverage on corporate balance sheets.

Businesses took on debt in the aftermath of the Great Financial Crisis as the Federal Reserve and other central banks, including the European Central Bank, kept interest rates pegged at zero or below, pushing corporate debt businesses to new heights.

This has caused the stock of US corporate debt to rise to more than 50% of gross domestic product, Colas said. To put that into context, the initial estimate of second-quarter GDP, released last month by the Bureau of Economic Analysis, put the size of the U.S. economy at $24.85 trillion.

“When you have that much debt on a balance sheet, higher returns become problematic much faster,” he said.

Rising yields are also why many market strategists expect value stocks, a group that includes companies like JPMorgan Chase & Co. JPM,
-1.85%
and International Business Machines Corp. IBM,
-1.99%,
will continue to outperform growth stocks, or a group including Netflix Inc. NFLX,
-6.51%
and Amazon.com Inc. AMZN,
-3.75%

Simply put: stocks with less leveraged balance sheets are better positioned to outperform in a rising interest rate environment.

See: Value stocks are showing their best stretch in 20 years against growth stocks, but that’s starting to change. Why?

“That’s precisely why you’ll go from growth to value. High-margin companies are likely to do a lot better,” said Tavi Costa, portfolio manager at Crescat Capital.

US stocks continued to slide on Monday after the S&P 500 ended a four-week winning streak on Friday. The S&P 500 SPX,
-2.23%
was down 91 points, or 2.2%, in afternoon trading.

The Dow Jones Industrial Average DJIA,
-2.01%
was down 650 points, or 1.9%, at 33,055, while the Nasdaq Composite COMP,
-2.62%
was off by 313 points, or 2.5%, at 12,391.

All three indexes were on track for their biggest daily decline since June. In comparison, the 10-year Treasury yield TMUBMUSD10Y,
3.038%
rose 4.6 basis points to 3.028%.

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