Investors are hotly debating whether a 3% yield on the 10-year Treasury note will upend the stock market.
But David Rosenberg, chief economist at Gluskin Sheff, says that debate doesn’t correctly frame the issue. Instead, investors should be focusing on how far yields rise rather than an arbitrary number.
“Markets always and everywhere respond to the change that occurs at the margin,” said Rosenberg, in a note earlier this week. The 10-year Treasury yield TMUBMUSD10Y, -0.87% has moved up around a 170 basis points, or 1.7 percentage points, from its post-Brexit low. Back in June 2016, Britain’s vote to depart the eurozone stoked geopolitical concerns, boosting demand for havens, including Treasurys, pushing the 10-year yield to an all-time intraday low of 1.27%. Yields and debt prices move in opposite directions.
The 10-year yield pressed above 3% for the first time since late 2014 at midweek, peaking at 3.03%. On Friday, it traded near 2.961%. Stocks sold off sharply after the 10-year yield briefly touched 3% on Tuesday, but then took back some lost ground. The S&P 500 SPX, +0.15% is off less than 0.1% for the week, while the Dow DJIA, +0.02% is down around 0.7%.
Rosenberg offers his own twist on the magical number theory. He argued that history shows that rather than any specific level, nor even so much the shape of the yield curve, that causes market turmoil. Instead, it’s a 200 basis point rise in the 10-year yield that tends to push markets to the breaking point. He elaborates:
|It was NOT the 5.3% LEVEL on the 10-year T-note yield by the summer of 2007 that ultimately brought the stock market to its knees, it was the 200 basis points runup from 2003 post-crisis yields lows – the CHANGE – that did the trick. It was not the 6¾% yield on the 10-year T-note that undid the dotcom bubble back in 2000; it was the 200 basis point surge from the post-crisis (Asia and LTCM) yield lows in late 1998. It was not the 9% yield on the 10-year T-note that caused the bear market and recession in 1990-91, but the 200 basis point move off the 1987 trough that caused it.|
“This will (and is) pack a powerful punch for anything that is valued on the direction … of interest rates,” he said.
But David La Placa, founder of Intellectus Partners, says the change in interest rates reflects a return to normalization, with the 10-year yield moving closer to their long-term fair value, which closely tracks the gross domestic product growth of the U.S.
It’s why he was not “convinced” that a 10-year yield between 3% to 3.5% would hurt the economy or the stock market, as it reflected where annual GDP was expected to hover this year. One model of the benchmark bond’s fair value by Société Générale, suggests the 10-year Treasury yield should trade at 3.30%, not far off where a 200 basis point rise from the post-Brexit low would put it.
“Recall that in every past cycle we had both interest rates much higher as well as growth. It is the delta between that two that is the thing that we are most focused upon,”said La Placa.
What would be worrisome, then, is if growth did not accelerate along with rising interest rates, “then it would be a real concern,” he said.
Yet Rosenberg, who is down on U.S. growth prospects, said if “rising rates were truly commensurate with a buoyant economy”, sectors reliant on low borrowing costs wouldn’t still be in the doldrums.
Home building, car manufacturing, home furnishing and real estate stocks have suffered steeper falls than their peers in other industries.
The S&P 500 homebuilding index is down 11.55% year-to-date, compared with an overall 0.2% drop over the same period in the broader index. While, automakers are down 5.4% year-to-date.