How Surging Yields Brought the Stock Rally to a Halt, in 8 Charts
The bond selloff is likely to have lasting effects on stocks
A surge in bond yields has interrupted the 2023 stock rally, leaving investors sifting through market signals to predict what comes next.
Stock investors are scrutinizing the bond market because yields affect everything in markets and the economy, from corporate borrowing costs to the present value of future earnings and the likely direction of stock indexes.
That means the bond selloff, which recently drove the yield on the benchmark 10-year Treasury note above 4.8% for the first time since 2007, could have lasting effects on which stocks lead the market and when major indexes start climbing again.
The S&P 500 has retreated 5.5% from its July high, cutting its year-to-date advance to 13%, while the Dow Jones Industrial Average briefly gave up all of its gains for the year last week.
Analysts say the size and speed of the changes in long-term rates make it less likely that stocks are poised to embark on a sustainable new rally.
“Rates are really the name of the game right now,” said Garrett Melson, portfolio strategist at Natixis Investment Managers Solutions. “As long as you have that upward pressure on rates, that’s what’s really keeping the equity markets in this kind of stasis.”
The swift climb in yields has eroded one measure of the reward for holding stocks over government bonds—known as the equity-risk premium—to its lowest level in more than 20 years.
The S&P 500’s earnings yield, based on profits expected over the next 12 months, was just 0.766 percentage point higher Friday than the yield on the 10-year Treasury. That’s the lowest equity-risk premium since June 2002, according to Dow Jones Market Data.
The dwindling reward for risk-taking has weighed on prices throughout the stock market. Several commonly used technical indicators show the extent of the pullback.
The number of S&P 500 stocks hitting new intraday 52-week lows recently rose to the highest level since October 2022, while the share of stocks trading above their 50-day moving averages fell to its lowest level in a year, according to Dow Jones Market Data.
In June and July, as the index advanced toward its 2023 high, few stocks were making new lows and many were trading above their recent averages.
The low levels of the breadth metrics don’t mean the market has bottomed. But when the indicators start to improve, that can be a promising signal, said David Keller, chief market strategist at StockCharts.com.
The S&P 500 as a whole, meantime, has fallen close to its 200-day moving average, a long-term trend line consulted by analysts. It ended Monday 3% above the moving average. One day last week, it closed just 0.7% above the line.
“Holding the 200 day is one of those basic measures of: ‘Is this market holding up or is it potentially getting a lot worse?’” Keller said.
Falling below the moving average shows “there aren’t buyers coming in where you’d expect they normally would, and that usually is a concerning sign of a further bearish decline,” he said.
The S&P 500 rallied Friday, notching its best day in more than a month, after investors cheered signs of softening wage growth in the September jobs report. Technology stocks led the way higher, again powering the market after a recent spell of weakness. Investors are also watching the unfolding Israel-Hamas war for developments that could affect markets.
Rising interest rates hold the potential to spur a more lasting shift in market leadership. The low rates of recent years made the future growth promised by tech companies particularly attractive. If rates were to remain high, that could make far-off profits a less alluring bet.
So far, the tech trade hasn’t suffered much. A handful of large companies in technology and adjacent sectors account for most of the S&P 500’s advance so far this year. Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, Nvidia and Tesla make up 30.5% of the S&P 500, up from 21.5% at the end of last year.
In one sign of how the index’s large stocks are leaping ahead, the S&P 500 is on pace this year to outperform a version in which each constituent is equally weighted, rather than weighted by market value, by the most since 1998.
Utilities, consumer staples and real-estate stocks have slumped lately as higher yields make their sizable dividend payments less enticing.
Value stocks, traditionally considered those that trade at a low multiple of their book value, or net worth, also have lagged behind the market. Some investors expect that dynamic to reverse if rates remain elevated, since the prices of such shares tend to be less reliant on expectations of robust growth.
“You would own U.S. small cap and value stocks in that higher-interest-rate environment, as opposed to the large megacaps,” said Rick Pitcairn, chief global strategist of multifamily office Pitcairn. Instead, “nobody wants them.”
That might be because many of those stocks are seen as vulnerable to any economic downturn. But Pitcairn expects higher interest rates to persist long past the next recession, making small-cap and value shares attractive investments in the coming years.
The rise in yields has prompted some investors to question the lofty valuations commanded by some corners of the stock market. The technology sector traded last week at 24.9 times its projected earnings over the next 12 months, above a 10-year average of 18.6. The S&P 500 as a whole was priced at 18 times future earnings, slightly above its 10-year average.
Those valuation measures are based on forecasts for strong earnings growth. Wall Street expects corporate profits to take off next year, growing 8.2% in the first quarter of 2024, 12% in the second quarter and almost 14% in the third quarter, according to FactSet.
Some money managers are skeptical. Many expect that the tightening of financial conditions caused by the Federal Reserve’s interest-rate increases is still working to slow the economy.
“How does the economy reaccelerate and earnings reaccelerate alongside that with that macroeconomic backdrop? I just don’t see it,” said Matt Stucky, vice president and chief equity portfolio manager for Northwestern Mutual Wealth Management.