Bonds avoided many investors because the lower rates made them unattractive relative to equities. On Thursday, the bond market prevailed in some investors.
The 10-year treasury yield jumped by 9 basis points to peak at more than 1.49% on Thursday and reach its highest level since February 2020. The increase set the standard rate above the S&P 500’s dividend yield, which is 1.43% according to the FactSet calculations based on payouts from the past 12 months.
The milestone is important for large investors who monitor valuations over assets, as treasury is considered the risk-free rate, meaning stocks have lost their premium above bonds, and yet are risky securities. Thursday’s move reinforced fears that an exchange of shares and bonds would accelerate as higher rates make high stocks less attractive.
Bond yields rose sharply this month with the 10-year rate reaching more than 35 basis points. The progress was driven by expectations of stronger economic growth as well as an increase in inflation.
“The interest rate story since March 2020 has played a key role in increasing risk assets in asset classes with optimism ahead of the real broader economic recovery,” said Gregory Faranello, head of US rates trading at AmeriVet Securities. “A continued rise in U.S. long-term rates will at some point provide a value proposition, especially if we have the opposite of 2020, with returns now lowering risk assets and widening financial conditions.”
Many strategists cite the rising returns as to blame for the weakness in technological stocks as well as the increased volatility in the broader market. Higher rates can hit the growth-based technology sector particularly hard because they benefit from easy lending.
Yields continued their march even after Federal Reserve Chairman Jerome Powell downplayed the risk of inflation, saying it could take three years to consistently reach the central bank’s target. He said inflation was still ‘soft’ and that the central bank had the tools to fight it if it got hot.
“The rise in yields is mainly driven by rising inflation expectations,” said Joseph Kalish, chief macro strategist at Ned David Research, in a note. “More recently, expectations of better economic growth have increased in the course of real returns and increased inflation and liquidity premiums.”
Dividend yields, calculated as annual distributions divided by share prices, declined as the stock market rose to new highs, and yet companies did not raise much dividends amid the pandemic.
S&P 500 dividends fell $ 42.5 billion in the second quarter of 2020, followed by another $ 2.3 billion in the third quarter, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. Payouts recovered $ 9.5 billion in the fourth quarter last year as companies survived the worst health crisis.
If Corporate America could increase its dividends, which would increase the overall dividend yield, the stock market could gain the lead over bonds.
To be sure, dividends have become less important over the past few years as high-tech stocks that largely avoid the payouts have led the market.
And stocks still offer a premium over bonds when earnings are taken into account. According to FactSet, S&P 500 members will earn $ 172.26 per share this year. The amount divided by the present value of the S&P 500 gives a so-called earnings return of 4.4%, which is also a way for investors to value assets against each other.
CNBC’s Nate Rattner contributed to this article.
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