Here’s what 5% bond yields mean for the stock market — and which stocks to buy
Rising bond yields make the path for stocks shakier, but they won’t derail the bull market, according to Wall Street analysts. The 10-year U.S. Treasury note yield – a benchmark rate that influences mortgage rates, auto loans and borrowing costs – reached its highest level in 19 years Tuesday, topping 5.04%. On Wednesday, the Federal Reserve is likely to hike its short-term interest rate to tamp down inflation. The moves are not without their challenges for stocks. Rising rates are a headwind for equity valuations because they reduce the present value of future earnings, which are a key driver for stocks. At the same time, higher yields provide a relatively risk-free alternative to stocks, pushing investors to get defensive. Goldman Sachs and others do not believe those are reasons to be bearish on stocks overall, but rather a time to change strategy. The firm expects the “bull market will continue” due to strong earnings and healthy company balance sheets, its analysts wrote in a Friday note to clients. @TY.1 YTD line 10-year Treasury yield YTD. History also suggests the market can withstand tighter monetary policy. Goldman found that the S & P 500 generated an average return of 9% or more during the 12 months following the Federal Reserve’s first hike. Although stocks typically struggled during the first three months, they recovered as investors saw earnings growth. Overall this year, stocks have “absorbed the rise in bond yields well,” JPMorgan said in a note Monday to clients. That’s because stocks this year have been boosted by strong earnings and forward-looking forecasts. Therefore, analysts believe the positive correlation between stocks and bond yields can “stay in effect.” In fact, JPMorgan has argued that stock weakness from “geopolitical escalation as a buying opportunity.” Others take a more cautious view. If yields continue to rise, that “balancing act may become more difficult” for stocks, Barclays said in a research note Tuesday. If 10-year Treasury yields continue to move higher past 5%, analysts noted that would likely require higher earnings yields. But with earnings growth expected to moderate, “achieving that adjustment may increasingly require lower equity prices rather than stronger earnings,” analysts wrote. Still, there are opportunities in specific pockets of the market. According to Goldman, a helpful way to distinguish these opportunities is between short versus long “duration” stocks. Short duration stocks derive their value from profits and cash flow being produced now whereas long duration stocks get their value from profits expected further into the future and are generally more sensitive to rising bond yields since their cash flows are distant. Short-duration stocks Goldman identified the following companies as the newest additions in its short duration stock list: Whirlpool Lennar Conagra Brands Biogen Cigna Group Super Micro Computer Accenture Goldman models that the “equity duration,” or how long it will take for a company delivers cash to investors based on how sensitive a stock’s price is to changes in interest rates, is much shorter than the stocks under the long duration list. Long duration stocks On the other side of the trade, Goldman identified these companies as the newest additions as long duration stocks that could face greater pressure if yields continue to climb: Cava Las Vegas Sands Coca-Cola Moderna Bloom Energy Applied Digital IonQ TeraWulf CoreWeave Their inclusion doesn’t mean Goldman expects their businesses to deteriorate. Rather, their valuations depend on profits expected in the future and so therefore could contract. Goldman overall noted the sensitivity of equities to rates varies widely, the firm called out consumer staples, energy, financials and healthcare as sectors that tend to outperform when interest rates rise.
