(Updated 03/13/2018)
A headline on Bloomberg —"Goldman Says Stocks May Plunge 25% If 10-Year Yield Hits 4.5%" —said that:[1]
In this article, we will touch upon the sensitive issue of rising interest rate and how far it rises is too much for the economy to accommodate. Note that we will not cover another related topics—the speed of rising interest rates, which could be summarized as follows:
Job creation remained solid in the small business sector as owners reported a seasonally adjusted average employment change per firm of 0.22 workers, a strong showing and a repeat of last month.
A headline on Bloomberg —"Goldman Says Stocks May Plunge 25% If 10-Year Yield Hits 4.5%" —said that:[1]
If the 10-year U.S. Treasury yield hits 4.5 percent by year-end, the economy would probably muddle through -- stocks, not so much, according to Goldman Sachs Group Inc.
Goldman’s base-case scenario calls for a 10-year yield of 3.25 percent by the end of 2018, though a “stress test” out to 4.5 percent indicates such a move would cause stocks to tumble, economist Daan Struyven wrote in a note Saturday. He also said the economy would probably suffer a sharp slowdown but not a recession.
“A rise in rates to 4.5 percent by year-end would cause a 20 percent to 25 percent decline in equity prices,” the note said.
Remember that US Treasury traders are relatively unconcerned about credit risk. They believe that the US government can simply print sufficient dollars to pay its debts. The bigger worry is about the purchasing power of those future payments. In other words, they are almost exclusively concerned with inflationary expectations.
In this article, we will touch upon the sensitive issue of rising interest rate and how far it rises is too much for the economy to accommodate. Note that we will not cover another related topics—the speed of rising interest rates, which could be summarized as follows:
While stocks have historically tended to advance in the first year of policy tightening, the pace makes a big difference, according to Ned Davis Research, which defines a fast cycle as a hike per meeting. Since 1946, the S&P 500 fell 2.7% on average in this scenario while rising 11% during slower ones.
Interest rate
Interest rates move in very long cycles. They went up from the mid-1940s to the early ’80s, when long-term government bonds peaked at close to 16%, and T-Bills at over 16%. Then, they went down ever since. Years ago they hit bottom, but the cycle overshot. In Feb 2018, they finally broke out the downtrend line, which is a significant event.[2]
While a recent drop in stocks may have been fueled by concerns tied to the 10-year yield approaching 3 percent, many strategists have said they felt equities could continue to rise until reaching 3.5 percent or 4 percent.
For example, Russ Koesterich, CFA, a Portfolio Manager for BlackRock’s Global Allocation team and a regular contributor to The BlackRock Blog, has commented that:[3]
Low interest rate levels
While a recent drop in stocks may have been fueled by concerns tied to the 10-year yield approaching 3 percent, many strategists have said they felt equities could continue to rise until reaching 3.5 percent or 4 percent.
For example, Russ Koesterich, CFA, a Portfolio Manager for BlackRock’s Global Allocation team and a regular contributor to The BlackRock Blog, has commented that:[3]
Rates and multiples are more likely to rise in tandem when interest rates are rising from unusually low levels, as is the case today. Under these circumstances, faster growth is treated as a positive as it alleviates recession and deflation fears. In addition, faster nominal growth is also associated with faster earnings growth.
Unfortunately, there is a caveat. Rates and valuations can rise together—to a point. At some point the negative relationship between rates and valuations reasserts itself. In other words, at a certain level higher bond yields create real competition for stocks, particularly dividend stocks, and put downward pressure on multiples.
Based on Wednesday’s market action we’re clearly not at that point yet. That said, if bond yields were to climb substantially, let’s say towards 4%, history suggests that the negative relationship between bond yields and equity valuations will begin to reassert itself. I would be particularly concerned as higher rates would be rising against a backdrop of an older population with a taste for income and elevated debt levels. But for now, higher rates and higher stock prices can probably co-exist.
Current 10-Year US Treasury Yield
Current reading of the 10-Year US Treasury Yield was 2.88 on 02/23/2018.
References
- Goldman Says Stocks May Plunge 25% If 10-Year Yield Hits 4.5%
- This chart warns that the 30-year downtrend in interest rates may be over
- Yes, rates and stocks can rise together…. for now
- Foreign Investors Have Lost Confidence In US Government
- Based on some assumptions he made, John M. Mason said that the nominal yield on the 10-year Treasury note could rise to as high as 3.7 percent
- More About the Bond Market’s Transitory Thinking
- Knowing the Basics of P/E Ratio
- It Starts With Inflation (Ray Dalio)
No comments:
Post a Comment