The real yield of 10-year U.S. Treasury bonds has turned positive. What does this mean?

Real returns turned positive, meaning investors were still getting positive returns on the 10-year Treasury note after factoring in expected inflation. Affected by this, high-risk assets may face the risk of revaluation in the short term, and start-ups and technology companies may “bear the brunt”.

The U.S. bond market has taken a key step toward returning to “normalization” before the new crown epidemic.

On April 20, the inflation-adjusted 10-year benchmark U.S. Treasury yield, known as the U.S. 10-year inflation-protected bond (TIPS) yield, rose above zero for the first time since March 2020, to 0.008%.

Since real interest rates and inflation expectations cannot be directly observed, in practice, the nominal yield of TIPS is often used to measure the real interest rate in the United States. The difference between the nominal yield of government bonds of the same term and the yield of TIPS is the breakeven inflation rate (BEI, Breakeven Inflation Rate). , is regarded as the market’s implied inflation expectations.

Recently, TIPS yields have been pushed to three-year highs as investors expect the Fed to continue to tighten policy. The positive 10-year TIPS yield means that investors can still achieve positive returns on 10-year U.S. bonds after factoring in expected inflation. Previously, TIPS yields remained below zero for a long time due to the unlimited QE “big water release” initiative launched by the Federal Reserve to offset the impact of the epidemic, which enhanced the attractiveness of the US stock market and pushed the S&P 500 index to double from the low point of the epidemic.

However, rising bond yields are taking the luster from U.S. stocks. As of Tuesday’s close, the S&P 500 is down 6.4% since the start of the year, while the 10-year TIPS yield has climbed more than 100 basis points. In this regard, Barry Bannister, chief equity strategist at Stifel, an independent investment bank in the United States, said:

“As real yields rise, it makes stocks less attractive.”

On the other hand, the signals from the bond market are also worthy of investors’ attention. As shown in the chart below, the movement of the 3-month short-term interest rate futures curve shows that market expectations have shifted to a faster pace of tightening and that a recession in the U.S. economy may begin in mid-2023 (compared to January, 4 The near-end of the curve is significantly steeper and peaks around June 2023, and then begins to fall). Generally speaking, the short-term interest rate futures yield curve is one of the most accurate predictors of the business cycle.

On the basis of the expected economic downturn leading to the decline in the market’s expected corporate profit growth rate, and the impact of higher risk-free interest rates, the risk of lower equity risk premium ERP is also worthy of investors’ attention (it can be easily understood as E(r)=Rf+β*ERP ). The ERP metric is at its lowest level since 2010, according to a report last week by investment advisory firm Truist Advisory Services.

In this context, it is time for global investors to “fasten their seat belts”high-risk assets may face revaluation in the short term , and start-ups and technology companies may bear the brunt. The rationale is simple: high-risk growth stocks, given the widely-adopted dividend discount (DDM) valuation system, are naturally more discounted due to higher discount rates because most of their expected returns are at the far end.

Empirical research also reflects this: According to Reuters statistics, since 2018, the ratio of the performance of the Russell 1000 Growth Index to the Russell 1000 Value Index (cash flow is closer than the former) has been negatively correlated with the 10-year real interest rate, and the correlation coefficient as high as 0.96. That means they tend to move in the opposite direction of growth stocks, said Ohsung Kwon, U.S. equity strategist with BofA’s global research team:

“It’s a headwind for the stock market.”

In addition, Reuters also warned that although the “slump” in the stock market this year has “moderated” stock valuations, the S&P 500 is still trading at 19 times forward earnings, higher than the long-term level of 15.5 times.

However, there are also investors who believe that even if real yields are threatening stock market valuations in the short term, the stock market is still “fearless” in the long run. The reason: Real returns have mostly been in positive territory over the past decade, but the S&P 500 has risen more than 200% over the same period, and the tech-heavy Nasdaq has risen more than 380%.


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