U.S. Stocks Are at Risk of Long-term Declines Due to Soaring Treasury Yields

The surging U.S. Treasury yields are further enhancing the attractiveness of bonds over stocks, exacerbating an already distressing decline in equity markets while potentially imposing a long-term burden on the performance of stocks.

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Over the past 15 years, the allure of stocks had been greatly bolstered by the fact that bond yields were hovering near historic lows. This trend was particularly pronounced as the U.S. Federal Reserve maintained near-zero interest rates to prop up the economy in the wake of the 2008 financial crisis.

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However, the trajectory of Treasury yields in the current year is altering this calculus. Government bonds have now become more appealing as they offer a source of income considered risk-free by investors who intend to hold them until maturity. The yield on the pivotal 10-year U.S. Treasury note, which moves inversely to bond prices, recently reached 5%, marking its highest level since 2007. This ascent has been driven by mounting concerns surrounding the Fed's hawkish policies and fiscal uncertainties.

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As a consequence, numerous investors are reevaluating the role that stocks should play in their investment portfolios. Data from BofA Global Research's most recent survey shows that fund managers have favored bonds over stocks for eight out of the ten months in 2023. They are currently holding an allocation that exceeds their average historical preference for bonds while simultaneously underweighting stocks.

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The recent surge in yields, which commenced in the summer, has exacted a toll on stock investors. Although the S&P 500 index has managed to advance approximately 9% since the start of the year, it has experienced an 8% decline since late July, marking the peak for the year. During this period, the yield on the 10-year Treasury note has risen by approximately one full percentage point.

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Quincy Krosby, the Chief Global Strategist for LPL Financial, commented on the situation, stating, “It isn’t as if we have never had 5, 5.5% - that was the norm. What is difficult for the market is that has not been the norm for many years. The market is having to adjust to a new calculus.”

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Escalating bond yields are elevating the cost of capital for companies, posing a threat to their balance sheets. Notably, Tesla's CEO, Elon Musk, expressed concerns last week regarding the impact of high interest rates on potential car buyers.

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In summation, the rising U.S. Treasury yields are reshaping the financial landscape, prompting a shift in investor sentiment towards bonds at the expense of stocks. The historical backdrop of near-zero interest rates has given way to a new paradigm where government bonds are offering an attractive risk-free source of income. This shift is impacting asset allocation strategies and market dynamics, and it has also raised concerns for corporate entities reliant on accessible capital. As the financial landscape continues to evolve, investors and businesses alike must adapt to this changing calculus.

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