Another day, another debate about what level on 10Y yields is the “magic” number beyond which equity investors start taking headers off bridges.
To the extent this wasn’t already a veritable obsession for markets (and actually, there is no extent to which it wasn’t already an obsession because it’s all anyone has been talking about since the average hourly earnings number earlier this month), it was back in focus on Wednesday afternoon when stocks nosedived during the final hour of trading as long end yields surged following the Fed minutes.
There’s a lot of nuance to be had in terms of deciphering the minutes and we tried to provide a bit in the way of useful analysis re: what was driving yields higher yesterday afternoon. You should check out our Wednesday market wrap on that if you haven’t yet.
But whether it’s inflation fears or simply the fear of more rate hikes or a combination of both (where real yields become a function of rising price pressures as the Fed leans more hawkish in response to the expected effect of piling fiscal stimulus atop an economy at full employment), the bottom line is that when it comes to the market topic du jour, everyone is going to be serving bowls of “choose your 10Y yield threshold” for the foreseeable future.
Of course as Morgan Stanley was humble enough to point out earlier this week, no one knows for sure what the actual pain threshold is. And there’s certainly an argument to be made that it’s the rapidity of rate rise that matters, not any specific level.
Well on Thursday, Wells Fargo’s Christopher Harvey is out weighing in with his take and there are some possibly useful nuggets from his note that we thought we’d highlight given the overriding interest in this topic.
“Clients and colleagues are asking if there’s a magic interest rate that’s kryptonite to stocks; is it 3.0% or 3.5% on the 10Yr Treasury?,” Harvey writes, before giving the same answer as Morgan Stanley: “Our simple answer is no, not really, assuming further interest rate rises remain orderly.”
Here are three key bullet points from the note along with one of the tables that might prove useful as a handy reference guide:
- Since ’99 the S&P500 has returned, on average, 12.5% during a significant interest rate rise. YTD there’s a positive correlation (0.44) between the daily returns to the S&P500 and the daily change in the 10Yr Treasury yield. Contrary to popular belief, the ‘18 numbers indicate rates up, stocks up.
- So what should we typically expect in a rising rate environment? Overall, a rising rate environment can be characterized as a ‘risk on’ period with Investment Grade Credit spreads tightening (avg -58bps), positive returns to Volatility factors (avg 14-18%), Small Caps outperforming (avg 9.2%), and the S&P500 rallying (avg 12.5%) while the 10Yr Treasury yield has a significant increase (avg 94bps).
- This is more or less what we’ve experienced since early Sept ’17 (9/7/17-2/21/18). In that time, the S&P500 has returned 10.5%, the 10Yr Treasury yield has increased 91bps, the return to our Volatility factors are 3-6% and Investment Grade Credit spreads have tightened about 20bps. Small Caps which typically outperform are lagging the S&P500 but by less than 50bps.
So, I suppose you can take all that to mean a) stay long and don’t worry about steady rate moves, b) the positive correlation move has played itself out over the last year and further rate increases will stretch it into a reversion, or c) fuck it, take a vacation for the next year or two.