Falling Treasury yields provide cover for U.S. equities

Brian Nick

The last week’s market highlights:

Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2021 Outlook:
  • U.S. economy: Getting worse before it improves. 
  • Global economy: Ready to get back to normal—with the help of vaccines.
  • Policy watch: No Federal Reserve interest-rate hikes until at least 2023.
  • Fixed income: A modest-risk overweight with a focus on credit sectors.
  • Equities: Lean toward small caps, emerging market shares and dividend payers.
  • Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.

Quote of the week:

"You must never be fearful about what you are doing when it is right.”– Rosa Parks

Recapping the Treasury market

What a ride it’s been for long-term U.S. Treasury securities during the pandemic. Take the bellwether 10-year Treasury note, a gauge of investors’ outlooks for GDP expansion and inflation. Its yield declined from 1.92% on January 2, 2020 to a record low 0.52% last August.4 What drove the sharp drop?
  • Growth and inflation expectations collapsed amid panic about the pandemic’s economic impact.
  • The Fed cut interest rates to near zero and pledged to keep them there until “the economy has weathered recent events” — namely, the pandemic. (Although Fed rate actions are more directly reflected in the movement of short-dated Treasuries such as the 2-year note, tighter or looser monetary policy can still affect the longer end of the Treasury yield curve.)
  • Extra demand for Treasuries, driven by the Fed’s monthly quantitative easing bond-buying program, drove their prices up and their yields down. (Bond yields and prices move in opposite directions.) 
Last summer, the 10-year yield began to rise from its historically depressed levels. In November, the combination of an expanding U.S. economy, reduced U.S. political uncertainty following the election and approval of several vaccines pushed up the yield to 0.98% — an eight-month peak.5 The 30-year bond followed suit, reaching 1.75%.6
Turns out last November’s jump was a mere warm-up. Indeed, prior to last week, the 10-year had risen for eight straight weeks, hitting a post-pandemic high of 1.74% on March 19.7
Also providing a boost: markets don’t quite believe the Fed’s assurances that it will keep its benchmark federal funds rate at the current 0%-0.25% range through at least 2023. With GDP forecasts — including the Fed’s — improving noticeably, investors are expecting rate “liftoff” well before 2024.
Against that backdrop, investors may be wondering if rising yields present a problem for their portfolios. Broadly speaking, we don’t believe so, although the value of existing bonds will decline as yields rise. Higher yields suggest the bond market anticipates better economic times ahead, bolstered by the Fed’s accommodative monetary policy. That upbeat sentiment was evident in the March U.S. Composite Purchasing Managers’ Index (PMI), which capped its strongest quarter of manufacturing and service-sector growth in 6½ years.8 
Moreover, financial conditions remain quite loose, a positive for the economy. Credit spreads — the extra yield investors demand for investing in bonds other than U.S. Treasuries — are tight, meaning companies can still borrow at low rates. And surging stock prices over the past year have made consumers feel richer (courtesy of the “wealth effect”), which may support future spending. Lastly, Treasury yields are still low by historical standards. Over the past 20 years, the 10-year has averaged 3.12% (versus its 1.67% close on March 26) and the 30-year, 3.80% (compared to 2.39%).9
Of course, today’s market environment has created winners and losers. Financial stocks have outperformed the broad S&P 500 Index by a whopping 11% for the year to date, aided by the upswing in rates and a steeper yield curve.10 Banks, a substantial component of the financials sector, benefit from the wider spread between short-term rates (which determine the interest they pay on deposits) and long-term rates (on which they base how much interest to charge on loans).
In contrast, technology stocks have struggled versus the S&P 500 for the year to date, in part because they sometimes perform like long-duration bonds in that their “yield” is their expected delivery of high earnings growth. As rates climb, the present value of those anticipated earnings falls. Utilities — a so-called “bond proxy” — have also lagged the overall market as their dividends have become less attractive compared to the healthier payouts offered by ultra-safe Treasuries.11
A potential danger signal for the equity market would be a sharp rise in rates driven by a Fed that tightens faster and sooner than it currently plans to. But we think that’s unlikely given the lengths to which Chair Jerome Powell and his colleagues have gone to (1) explain their greater tolerance for inflation to run above the Fed’s 2% target and (2) commit to maintaining near-zero rates for at least the next few years.
So what’s our outlook for the 10-year Treasury yield for the remainder of 2021? We believe its rapid ascent is unlikely to continue. Inflation expectations have already normalized amid the improving economic landscape, and we doubt runaway inflation fueled by further growth this year is in the cards. That suggests a more modest rise in the 10-year yield from here, to what we expect will be around 2% by the end of the year.

Did you know?

By now, many Americans have received their $1,400 stimulus checks courtesy of the Biden Administration’s American Rescue Plan Act (ARPA). But what might they do with the money? And what have they done with prior fiscal stimulus relief aid?
In a survey conducted last June, the New York Federal Reserve found that, on average, of the $1,200 received as part of the March 2020 CARES Act, respondents:
  • Saved or invested 36%
  • Used 34% to pay down debt
  • Spent 18% on essential items
The remaining 12% was roughly split between donating and spending on non-essentials.12
When asked two months later how they might allocate an additional $1,500, respondents said they would save or invest even more — 45% of the total, or $675, to be exact.13 And indeed, that may be what’s happened to the $600 per person allocated as part of last December’s $900 billion stimulus. Those checks began to go out in January, leading to a huge surge in personal income and a small burst of spending. It appears some of the money has also found its way into brokerage accounts. According to the Financial Times, for the four weeks ended March 17, investors poured $168 billion into equity funds.14 Other assets, including high-flying “meme” stocks and cryptocurrencies, may also have benefited from an influx of federal aid.
These inflows jibe with the closely watched weekly sentiment survey conducted by the American Association of Individual Investors (AAII). As of March 25, 51% of AAII respondents believe stock prices will be higher six months from now. That marks a fresh 2021 high and sits 13 percentage points above the survey’s historical average of 38%.15 At the same time, the percentage of respondents who believe stocks will be lower in six months’ time has dropped to under 21%, the lowest level since December 2019.16 (As it turns out, the last time bears found themselves in this small a minority, they ended up being correct.)
Plunging into the stock market simply because others seem to be doing so doesn’t strike us a prudent reason for increasing one’s equity exposure. Put another way, we think investors may take on undue risk when they let “FOMO” (fear of missing out) be their guide, especially when this applies a single security or a hot investing trend. As always, we believe investors are better served by sticking to their long-term investment plans and asset allocations, regardless of the latest fads or whether short-term market headlines are positive or negative.
  1. Marketwatch
  2. Russell
  3. Bloomberg
  4. U.S. Treasury via FRED
  5. U.S. Treasury via FRED
  6. U.S. Treasury via FRED
  7. U.S. Treasury via Haver
  8. Markit
  9. Nuveen, U.S. Treasury via Haver, Marketwatch
  10. Bloomberg
  11. Bloomberg
  12. New York Fed via Liberty Street Economics
  13. New York Fed via Liberty Street Economics
  14. Financial Times
  15. AAII
  16. AAII
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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