The bond market is signaling trouble ahead for stocks
One signal coming from the bond market could spell difficulties ahead for the stock market, according to Jefferies. While investors typically look at the 10-year Treasury yield for a read on the economy, and the market, Jefferies argues that the 10-year Treasury inflation-protected securities bond is a better gauge right now. The principal on TIPS principal fluctuates over their term based on the Consumer Price Index for All Urban Consumers. Their yields are a real rate of return — in other words, what investors earn above the rate of inflation. The 10-year TIPS is currently sitting at 2.36%. “[An] analysis of TIPS data (last 30 years) shows weak global equity returns when TIPS moves beyond 2% ( > 70th percentile),” said Desh Peramunetilleke, Jefferies’ head of quantitative strategy. The strategist found that since 1997, the S & P 500 had a monthly average return of 0.2% when TIPS were in the 70th to 100th percentile. Japan’s market suffered the most at such times, seeing a 0.5% monthly average loss, while Latin America had the best performance at a 0.3% monthly average return. Peramunetilleke doesn’t anticipate those TIPS yields coming down anytime soon. “Real yields near 2.5% look more durable as fiscal risk drives up the term premium, while AI-related borrowing keeps long-duration funding costs elevated,” he said in a note Thursday. Fiscal risks have been growing as the federal government racks up more and more debt. On Wednesday, the Treasury Department said the United States budget deficit jumped to $432.3 billion in July , the largest monthly deficit since March 2021. At the same time, technology companies have been turning to the bond market to finance their massive artificial-intelligence build outs. Global capital expenditures are expected to rise at an “unprecedented” 28% rate in 2026 from last year, Peramunetilleke said. “With the new Warsh-led Fed taking a more hands-off approach, we do not see the term premium coming off if inflation risks and the fiscal deficit are not contained,” the strategist wrote. In this environment, investors should focus on quality and yield, Peramunetilleke said. Sectors like software, financial services and discretionary retail tended to outperform in past periods similar to the current one, he noted. To find potential winners, he screened for high-quality yield stocks with low price-earnings ratios. Companies such as JPMorgan Chase , Pfizer , ConocoPhillips , McKesson and Dollar Tree emerged as leading candidates.
