Two Reasons To Doubt The Narrative On Yields And Stocks

Have you run out of fun ways to implicitly lampoon the hysteria around 10Y yields at 3%?

More specifically, have you run out of ways to communicate that you think the hoopla might be overdone while simultaneously ensuring that in your zeal to make fun of everyone else, you hedge your language enough that in the event the locusts actually do come, you can retain some credibility?

That’s ok, everyone else has run out creative ideas too, which is why folks are just going with shit like “highway to the danger zone?” now.

That’s the title of a quick morning note from Barclays which finds the bank suggesting that “perhaps we should not be terribly surprised by yesterday’s price action” in stocks considering “clients said a 3% treasury yield was the beginning of the ‘danger zone’ several weeks ago.”

They’re referring to their Global Macro Survey, in which clients opined that 3.00-3.25% was the level at which the yield-stock return correlation would flip negative or, more to the point, the level at which there’s no diversification.

For Barclays, there are “two reasons to question the narrative” and here they are:

1. First, even if yields stay here or even rise further, it’s not clear that this is in fact a level that is problematic for stock prices. Empirical evidence suggests that negative yield-stock correlation typically kicks in when yields are much higher; closer to 5% and above.

2. This plays into the second reason the ‘higher yields, lower stocks’ regime may not last: it’s not clear that higher yields are here to stay. Since rates are still probably far too low to be negatively correlated with stocks, then bonds still have some portfolio-dampening effect. This, among others, is one reason we think US yields will continue to trade lower than consensus expectations.

While that’s all fine and good, one thing I would note about both of those points is that it isn’t clear the “empirical evidence” they’re citing there holds anymore. That is, the post-crisis experience seems to suggest the “pain threshold” (if you will) for yields beyond which the stock-bond return correlation flips sustainably positive is lower now than it was in the past thanks in no small part to the persistence of ZIRP and NIRP across advanced economies.

And on that note, I’ll leave you with two visuals to ponder, one which reinforces the point I just made about the post-crisis experience having perhaps changed things and one from Goldman which suggests there’s probably still quite a bit of runway for stocks here in terms of when yields become a problem.

From BofAML