The "Virtuous" Link Between Stocks and Bond Yields May Be About to Break

There has been an inverse relationship between bond yields and stock prices in recent months, but that is likely to change as markets become more concerned about economic growth.

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The 10-year Treasury yield has climbed to just over 3.5% in the past year, while the S&P 500 has fallen by almost 9%. This is due to the Federal Reserve increasing interest rates in order to reduce inflation. However, concerns remain as inflation has fallen for the 6th consecutive month. The consumer-price index fell by 0.1% in December, compared to a 0.1% increase in November. The cost of services is still a problem, but overall inflation is slowly decreasing.

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The consumer-price index fell 0.1% over the month in December, compared with a 0.1% climb in November. However, the cost of services remains a problem.
When the Fed raises rates, it usually boosts yields on Treasury debt. However, this also hits corporate profits and stock valuations, and raises concerns about a potential recession. Therefore, it makes sense that stocks have been sliding when yields rise. On the other hand, signs that the Fed can win the fight against inflation raise hope that the central bank will continue to ease up on rate increases, allowing yields to fall as stocks gain.

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While some expect stocks and yields to stop moving in opposite directions, they haven’t yet. The 10-year yield is down from just over 3.8% to start the year, while the S&P 500 is up about 5%. Strategists at Evercore say that this relationship is “virtuous.” The inverse correlation between stocks and the 10-year yield may soon reverse itself. That would mean that stocks and the 10-year yield would rise and fall in parallel. With yields on 10-year U.S. government debt now sitting at just over 3.5%, and expectations for average annual inflation over the next decade coming in at around 2.3%, according to St. Louis Fed data, now looks like a fairly attractive time to buy in. Those who do so would be looking at a real, inflation-adjusted yield of just over one percentage point.

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The appeal of bonds is growing, especially as stock prices become more volatile. As the Fed's seven rate increases last year begin to take effect, investors are concerned about the impact on the economy and corporate profits. Bonds offer a safe haven for investors in these uncertain times. As demand for bonds increases, prices go up and yields go down.

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Simpson said that even if bond prices were to fall, buyers would likely step in and bring them lower again. This would push up yields on the 10-year note, but Simpson believes that this would not deter buyers from continuing to invest in bonds.

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As investors buy bonds, they might sell stocks because of the earnings risk they carry. Analysts have recently been reducing their forecasts of corporate earnings, and the cuts could keep coming for some time. The latest data on economic growth—gross domestic product increased at a 2.9% annual rate last quarter—show the economy has yet to slip into a recession, but if it does, that would be a reason to buy bonds as a haven.

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Earnings season is shaping up to be tough for consumer discretionary stocks. Estimates have plummeted, while the stocks have rallied. This could mean bad news for investors when companies start reporting earnings.

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GDP growth was higher than expected last quarter, but there are signs of weakness in the data. The next inflation report is due on Friday.
If bond yields fall as a result of increased buying, this would indicate a weaker economy and cause stock prices to drop. However, if investors see higher yields on bonds as a sign of economic optimism, they may be more inclined to buy stocks. Bank of America strategists are advising investors to sell stocks, as the market may be nearing a point where stock prices and bond yields will rise and fall at the same time. This would break the recent pattern.

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The 10-year yield is a key indicator to watch. If it drops significantly, it may signal that investors are rushing into the safety of bonds out of fear of a recession. In that case, it might be a good idea to lighten up on stocks, rather than buying more.