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It seems hard to believe a 10-year U.S. Treasury yield of 3% would be enough to terrify stock-market investors, says one widely followed market observer, but a fright from the rapid rise of short-term yields might be more plausible.
As you probably heard, the yield on the 10-year Treasury note TMUBMUSD10Y, +0.57% rose to briefly touch 3% for the first time in more than four years on Tuesday before pulling back. On Wednesday, the yield moved back above 3% and remains near 3.019% in recent action. Yields rise as Treasury prices fall.
Of course, long-term, risk-free rates inform the discount factors that are used to value equities, so rising yields can weigh on valuations. That’s all well and good, wrote Nicholas Colas, co-founder of DataTrek Research, in a Wednesday note, but in terms of capital allocation, “it would take an inveterate stock bear to argue that the S&P 500 can’t compound returns at better than 3% for the next decade.”
Stocks initially took Tuesday’s 3% toe-touch in stride, but then tanked in afternoon trade with the Dow Jones Industrial Average DJIA, -0.15% finishing with a loss of more than 400 points and the S&P 500 SPX, -0.05% ended 1.3% lower. Stocks were off modestly in Wednesday trading.
‘It would take an inveterate stock bear to argue that the S&P 500 can’t compound returns at better than 3% for the next decade.’
While the 3% milestone attracted a lot of comment, Colas argued that the yield on the 2-year Treasury TMUBMUSD02Y, +0.63% is more relevant. The yield on the 2-year note stands just below 2.5%.
Noting that he’s “more positive on U.S. stocks than this argument portrays,” Colas noted that year-to-date highs were set in January, which feels like a long time ago. Meanwhile, markets are choppy and positive earnings reports don’t seem to be helping the market much.
With that in mind, Colas asks:
If I offered you a no-fee risk-free contract to deliver a 2.5% annual return on the S&P over the next two years, would you take it? On the one hand, it’s well less than the historical market return. But…There’s no risk of drawdowns and at least it’s better than 2% inflation. You might be tempted.