U.S. stocks posted the best returns when 10-year Treasury yields rose to close to 4 percent, according to a study by Standard & Poor’s that tracked market performance since 1953.
The S&P 500 Index, the benchmark measure of U.S. equities, advanced 1.7 percent a month on average during periods when 10-year yields climbed to a range of 3 percent to 4 percent, according to data compiled by New York-based S&P. That’s the best performance among six categories of rising yields studied by the firm. Stocks began to fall when yields exceeded 6 percent, the study found.
While rising yields tend to boost borrowing costs for companies and act as “a depressant in intrinsic value calculations,” they can also suggest a strengthening economy and prompt investors to switch to equities, according to Sam Stovall, S&P’s chief equity strategist.
“The ‘sweet spot’ for equity prices appears to be a rising rate environment between 3 percent and 4 percent, as a growing economy reduces unemployment while increasing corporate earnings, yet does not trigger growth-slowing efforts by the central bank,” Stovall wrote in a report yesterday.
Stocks rallied last week while 10-year yields had the biggest weekly increase in eight months as the Federal Reserve raised its assessment of the economy. The S&P 500 yesterday climbed 0.4 percent to 1,409.75, the highest level since May 2008. The 10-year yield rose eight basis points to 2.38 percent, the highest level since October, according to Bloomberg Bond Trader prices.
No `Death Knell'
The S&P 500’s monthly gain averaged 1.2 percent when 10-year yields climbed to no higher than 3 percent, according to Stovall’s study. The return was 1.3 percent when yields rose to between 4 percent and 5 percent, the data show. The S&P 500 fell 0.03 percent a month when yields jumped to 6 percent to 7 percent. The loss widened to 0.5 percent when yields surpassed 7 percent, the study shows.
“Rising rates don’t necessarily sound the death knell of equity price advances,” Stovall wrote. “On the contrary, they could instead offer a catalyst to equity prices, as new cash from fleeing bond investors seeks a new home. The key seems to be where interest rates are relative to the ‘line in the sand’ at 6 percent.”
Fed Chairman Ben S. Bernanke has kept the central bank’s benchmark interest rate near zero since December 2008 and expanded the Fed’s balance sheet with two rounds of asset purchases totaling $2.3 trillion. S&P forecast the yield on 10-year notes to average no more than 3 percent through 2013 on expectations that economic growth will remain slow.
The U.S. economy will expand 2.2 percent this year, according to the median forecast of 72 economists in a Bloomberg survey. While that’s up from 1.7 percent in 2011, it’s less than the 3.7 percent average from 1983 to 2000.
“Should they be proven to have underestimated the speed with which interest rates climb in the coming year, history would say, but not guarantee, that rising rates might actually speed the price advance of equities, not slow them,” Stovall said.