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Higher bond yields have arrived.
The 10-year Treasury’s yield, which is closely linked to 30-year mortgage rates and other consumer loans, reached 1.49% on Thursday – its highest level in more than a year.
Well, these rising rates mean that investors should consider what changes, if any, to make to their stock market investments, which they generally use through plans like 401 (k) s. They also need to think about the potential effects of higher earnings on their mortgages and auto loans.
What are you pushing to increase yield? As the United States continues to emerge from its pandemic-induced recession, optimism has grown that more stimulus aid and widespread COVID vaccinations will help the economy expand rapidly later this year.
Therefore, the increase in bond yields usually indicates that investors are hopeful of further economic growth in the future.
But they can also indicate that a potential increase in inflation is coming.
Bond settlement pushed investors to abandon technology companies, which thrived in a home-based economy, and choose companies that should benefit from the end of the blockages.
On Thursday, the Dow Jones Industrial Average fell 560 points after breaking a record the day before. The S&P 500 fell 2.5%, its worst day in nearly a month after reaching its all-time high on February 12. Nasdaq Composite, which is heavily geared towards technology companies, fell 3.5% – its worst day since October.
Should you fear higher yields?
Some investors fear that an increase in bond yields and long-term interest rates will end the race for steady gains in the market. Remember that stocks rebounded to historical records, after a historic fall last spring. These gains can be threatened because higher yields make it more expensive to borrow money and this tends to slow economic growth, which can be bad for stocks.
Undoubtedly, inflation gains in the past year have remained modest. The economic break with the pandemic continued to suppress demand and kept inflation at extremely low levels. This helped the Federal Reserve to keep interest rates at historic low levels in an effort to help lift the economy out of recession.
Even before the pandemic, inflation over the past decade has remained low, with annual price gains remaining well below the Fed’s 2% target.
If rates are rising because the prospect of economic growth is improving, higher interest rates should not be a risk to the stock market, experts say.
“Unless there is a sustained rise in inflation, the increase in bond yields will have less of an impact on stocks,” said Richard Saperstein, investment director at Treasury Partners, a registered investment advisor, in a note. “Bond yields are rising now because the market is evaluating the reopening of the economy for the post-COVID-19 world and accelerating economic growth.”
How quickly bond yields increase can be as important as how far, experts say. See how changes can affect consumers:
How will higher yields affect stocks?
Equity investors should not be overly concerned about the recent rise in yields, according to David Lefkowitz, head of equities for the Americas at UBS Financial Services. That’s because there is growing optimism about economic growth and rates are finally “catching up” to the stock market’s optimistic growth outlook, he added.
In the past three months, 10-year Treasury yield has increased by more than half a percentage point, a rapid movement that is over 90% of all three-month periods since 1990, according to UBS Financial Services.
Still, stocks typically perform very well during these periods. On average, the S&P 500 reports a 3.9% gain (16.5% annualized) when interest rates rise by more than half a percentage point, data from UBS Financial Services show. Although returns tend to be slightly lower in the three months after a major change in rates – 2.5% on average – they are no worse than a typical three-month period.
The increase in yields has implications for the stock market and can make the shares of companies with high valuations less attractive. These types of stocks tend to be technology companies, whose prices are typically geared to growth rather than a steady return on dividends, such as consumer goods, utilities and real estate companies.
Rising rates tend to be favorable for more cyclical sectors, or companies whose businesses and stock prices tend to follow the business cycle. This includes sectors such as discretionary consumption, energy, financial, industrial and health.
Bank shares, which were hurt by lower interest rates last year, would make greater profits if interest rates continued to rise. And while the technology sector would risk declining if yields increased due to higher inflation, the sector’s growing free cash flow and recurring revenue sources would provide protection, said Saperstein.
Investors are turning to the corners of the market that would benefit from the reopening of the economy. During the week, the energy and financial sectors in the S&P 500 rose 6.8% and 1.6%, respectively. Meanwhile, the technology fell 4.5% in the week. Apple, Amazon, Facebook and Microsoft, companies that boosted the stock market’s rise in 2020, each fell by at least 2% on Thursday.
When is increasing income a problem?
Can long-term yields and rates rise long before they start to become a risk to stocks? In theory, yes, but usually only if an increase in rates starts to block economic growth.
Rising yields are likely to inject more volatility into the financial markets as investors debate when the Fed will be forced to tighten monetary policy, although that does not appear to be so soon.
Fed Chairman Jerome Powell played down concerns this week about potentially higher inflation and signaled that the central bank sees no need to change its ultra-low rate policies in the near future. The Fed projects that inflation will remain at or below the central bank’s 2% target until 2023.
Despite conventional thinking that rising long-term rates are bad for stocks, historical data shows that the broad S&P 500 has shown solid returns.
The S&P 500 averaged a total annualized return of 13% and increased 81% of the time during periods of rate increases (13 of 16), according to data from Truist Advisory Services.
“With the pandemic subsiding at the end of this year, the huge pent-up consumer demand, more fiscal stimulus on the way … it is difficult to see the recent increase in rates significantly hampering economic growth,” said Lefkowitz in a note.
Will this affect mortgage rates?
Several consumer loans are influenced by the levels of the US bond market, mainly mortgage rates.
Rising interest rates mean more expensive mortgages, which undermines the accessibility of potential buyers. And if fewer people are able to buy homes, it could also cause property prices to stagnate or even fall, hampering the increase in equity of current owners, analysts said.
Mortgage rates have risen in six of the past eight weeks, with the 30-year fixed reference rate rising above 3% last week, to its highest level since September, according to the Mortgage Bankers Association. As a result of these higher rates, overall refinancing activity fell 11% to its lowest level since December, but remained 50% above the previous year.
However, mortgage rates are expected to remain historically low and are expected to support a modest increase in the pace of sales for the year as a whole, according to Oxford Economics.
“Homeowners can take advantage of the low-rate environment by refinancing the mortgage, generating hundreds of dollars of savings each month and tens of thousands of dollars in savings over the life of the loan,” said Greg McBride, chief financial analyst at Bankrate, on a note.
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