(From MSN.)
If you’re looking for a reason to explain the stock market’s rough start to August, look no further than its cousin, the bond market.
The sleepy world of bonds doesn’t quite get the media attention the stock market does. So you might not have noticed that the 30-year Treasury yield has been creeping higher all year.
And after a spike over the past few weeks, yields are approaching the decade-highs hit last October.
(Click here to view larger image.)
This matters for several reasons. To start, pricing in the capital markets is relative. You can’t say that stocks are “cheap” or “expensive” in an absolute sense.
Stock prices are cheap or expensive relative to something, whether that something is earnings, sales (i.e., the price/earnings/sales ratios) or competing asset classes, like bonds.
The higher bond yields go, the cheaper bond prices go. So after the recent spike, bonds have gotten relatively cheaper compared to stocks.
Relative pricing isn’t the only variable though. Most companies regularly borrow to fund growth and to juice their returns. Well, the higher interest rates go, the more that these companies have to pay in interest. And every dollar paid in interest is a dollar that doesn’t flow through to earnings.
There are also secondary and tertiary effects. Higher interest rates affect how much debt consumers can realistically carry. With all else equal, an extra dollar spent servicing a mortgage, a car payment or a credit card bill is a dollar not available to be spent on that next latte at Starbucks or that next pair of Air Jordans.
So, higher bond yields also potentially precede a slowdown in corporate sales.
The question now becomes: How high do yields go from here?
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That’s a tough question to answer with any certainty. A longer view of Treasury yields shows that something really did change after the pandemic. Yields had been steadily falling since the early 1980s, and that trend abruptly reversed near the end of 2020.
As Ian has pointed out repeatedly over the past year, we’re now in a period of deglobalization. We’re “firing China,” so to speak, and that puts us in a very different macro regime. There isn’t an obvious cap here.
Hedge fund manager Bill Ackman recently said he expects the 30-year yield to top 5.5%. That’s just one man’s guess, of course. But it’s probably a good one, coming from Ackman.
If that’s where yields go from here, that would mean a roughly 18% decline in bond prices.
Charles Sizemore
Chief Editor, The Banyan Edge
**Disclaimer: We will not track any stocks in The Banyan Edge. We are just sharing our opinions, not advice. We will, however, provide tracking, updates and buy/sell guidance for the model portfolio in your service subscription.
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