Bonds were shunned by many investors because they were unattractive compared to stocks due to their rock bottom prices. On Thursday, the bond market may have gained the upper hand in the eyes of some investors.
The 10-year Treasury yield rose by more than 16 basis points to a high of 1.614%, the highest level since February 2020. According to FactSet calculations, the key interest rate was above the dividend yield of the S&P 500, which was around 1 .43% was based on the payouts for the past 12 months.
The milestone is important for large investors overseeing asset valuation as Treasuries are considered a risk-free rate. This means that stocks have lost their premium over bonds, but are riskier stocks. Thursday's move heightened fears that stock-to-bond rotation would accelerate as higher interest rates make soaring stocks less attractive.
Bond yields have risen sharply this month, with the 10-year rate rising more than 35 basis points. The progress was triggered by expectations of stronger economic growth and a pick-up in inflation.
"The interest rate story since March 2020 has been instrumental in driving risk-weighted assets across all asset classes up with optimism ahead of the actual general economic recovery," said Gregory Faranello, head of US interest rate trading at AmeriVet Securities. "A sustained rise in US long-term rates is going to be a value proposition at some point, especially if we have the opposite of 2020 as returns are now lowering risk-weighted assets and tightening general financial conditions."
Many strategists cited rising yields as the culprit for weakness in technology stocks as well as increased volatility in the broader market. Higher rates could hit the growth tech sector particularly hard as it has benefited from simply borrowing.
Yields continued to rally even after Federal Reserve Chairman Jerome Powell downplayed inflation risk. It could take three years before the central bank's goal was consistently achieved. He said inflation was still "weak" and the central bank had the means to fight it if it got hot.
"The rise in yields was mainly driven by rising inflation expectations," Joseph Kalish, chief global macro strategist at Ned Davis Research, said in a note. "More recently, expectations of better economic growth have driven real returns and increased inflation and liquidity premiums."
Dividend yield, calculated as the annual payout divided by stock prices, has declined as the stock market hit new highs, and yet, in the face of the coronavirus pandemic, companies have not increased dividends significantly.
According to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, S&P 500 dividends fell $ 42.5 billion in the second quarter of 2020, followed by a further decrease of $ 2.3 billion in the third Quarter. Payouts rebounded $ 9.5 billion in the fourth quarter of last year as companies weathered the worst of the health crisis.
If the American company could continue to increase its dividends, which would increase the overall dividend yield, the stock market could regain its advantage over bonds.
However, dividends have lost momentum in recent years as soaring tech stocks that largely avoid payouts have led the market.
And stocks still offer a premium over bonds when they factor in gains. According to FactSet, S&P 500 members will earn $ 172.26 per share this year, analysts estimate. This amount divided by the current value of the S&P 500 results in a so-called profit return of 4.4%. This is another way investors value assets against each other.
– CNBC's Nate Rattner contributed to this article.
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