Driven by a flight to safety, investors bought more U.S. Treasury bonds, keeping 10 -
year treasury yields below 2.0 percent during most of the fourth quarter.
In this vein, JPMorgan recently published research indicating that 10 -
year Treasury yields below 5 %, even in a rising interest rate environment, have historically correlated to rising stock prices.
The Dow and S&P indexes suffered some of their worst losses of the year last week, and a shocking price move in the bond market sent the benchmark 10 -
year Treasury yield below 2 percent, the lowest level in over a year.
Similarly, since July, we've observed an inverted yield curve, with the 10 -
year Treasury yield below the 3 - month Treasury bill yield.
Not exact matches
The U.S. Federal Reserve's gauge of inflation remains stubbornly
below its 2 percent target, but U.S. 10 -
year Treasury yields spiked to near four -
year highs in January as a bond sell - off gathered steam.
The
yield on the 10 -
year Treasury fell
below 2 % for the first time since May 2013 in early trading in Europe, while gold rose to a three - week high of $ 1.213.60 a troy ounce, as investors once again shunned anything that smelled remotely of risk.
Ultimately, he sees the S&P 500 in 2018 ending 9 percent higher than current levels as long as the 10 -
year Treasury yield stays
below 3 percent.
Prior to some of the past recessions, the two -
year Treasury yield rose above the 10 -
year yield, although at the moment, the former is still
below the 10 -
year note, but has recently moved closer to it.
Rates on government bonds in Germany and Switzerland fell further into negative territory after Brexit, while
yields on 10 -
year Treasuries dropped
below 1.5 % and touched record lows.
Though its risen recently, the real
yield on the ten
year Treasury hovers
below 1 % (the 2.48 % rate, minus projected inflation of at least 1.5 points), an extremely favorable number by historical standards.
The
yield on the 10 -
year Treasury note mostly traded above, then dipped
below 2.15 percent on Friday's employment report.
But
below that were the SPDR Bloomberg Barclays High
Yield Bond ETF (JNK), the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), the iShares iBoxx $ High
Yield Corporate Bond ETF (HYG) and the iShares 7 - 10
Year Treasury Bond ETF (IEF).
Even today, the
yield on the S&P 500 index is
below the 10 -
year Treasury note
yield.
Both long and short - term rates retreated, sending the
yield on the 10 -
year Treasury roughly 20 basis points (0.2 percent)
below its June 10, 2015 peak.
That will be tricky given that 10 -
year Treasuries currently
yield below 2.20 per cent and this would decline precipitously with a recession and any move to cut Fed funds.
Over the weekend, Jeff Gundlach, the CEO of investment services firm DoubleLine told Barron's that he believed the 10 -
year Treasury yield could test the 2012 low of 1.38 percent if the price of oil fell
below $ 40 a barrel.
At present, more than one - third of the publicly held float in
Treasury debt is financed at maturities of less than a
year and at
yields well
below 1 %.
Note that in the 1987 case, the unusually strong 10 -
year return reflects a move to the extreme bubble valuations in the late 1990's, which have in turn been followed by 13
years of market returns
below Treasury bill
yields.
Although the benchmark US 10 -
year Treasury yield is up around 60 % from its July 2016 lows, it's still way
below its 40 -
year average.
While I'm on the topic of equities, the S&P 500 dividend
yield, for the first time in nearly a decade, is now
below the
yield on the two -
year Treasury.
Our Investment Strategy Report published on March 19 compared equity and bond
yields over multiple business cycles and found that the 10 -
year Treasury yield might have to sustain levels exceeding 3.5 % (far above what we believe is likely this
year) before compelling a
year - end 2018 S&P 500 Index target range
below our current
year - end target of 2800 - 2900.2
The correction has brought the S&P 500 Index to a more attractive level, compared to its 30 -
year average of 16.7 x, and this means that the S&P 500 Index valuation has reached an attractive level, given 10 -
year Treasury yields that now are
below 3.00 %.
More impressive still is that in spite of the Fed raising short - term interest rates by a total of 1.0 % since mid-December 2015, the approximately 2.30 %
yield on the 10 -
year Treasury as of mid-July is near where it was at the end of 2015 and 2016 (see the chart
below).
With respect to interest rates, after having fallen back
below 1.35 % on the 10 -
year Treasury note, last summer,
yields have climbed steadily this fall.
These conditions comprise the following: S&P 500 overvalued with the Shiller P / E (the ratio of the S&P 500 to the 10 -
year average of inflation - adjusted earnings) greater than 18; overbought with the S&P 500 within 3 % of its upper Bollinger band (2 standard deviations above the 20 - period average) at daily, weekly, and monthly resolutions, more than 7 % above its 52 - week smoothing, and more than 50 % above its 4 -
year low; overbullish with the 2 - week average of advisory bullishness (Investors Intelligence) greater than 52 % and bearishness
below 28 %; and
yields rising with the 10 -
year Treasury bond
yield higher than 6 - months earlier.
The Federal Reserve's policy errors are now becoming quite apparent, particularly when you look at the major homebuilder stocks, The
yield on the 10 -
year Treasury breached
below 1.80 today, but even lower mortgage rates aren't doing much to spur sales so far this
year.
The early weeks of 2015 are the first time in history that both 10 -
year Treasury yields and our estimates of prospective 10 -
year nominal total returns for the S&P 500 have both declined
below 2 % annually.
Last week, the
yield on the 10 -
year Treasury note broke
below 1.70 %, the lowest level since the spring of 2013, despite an upgrade in the Federal Reserve's (Fed's) assessment of U.S. economic conditions.
The difference in
yield between two -
year and 10 -
year Treasuries recently fell
below 50 basis points (source: Bloomberg).
This return also falls
below what seven -
year Treasury bonds were
yielding at the time, which was 6.1 percent.
For example, since 1950, the S&P 500 has enjoyed total returns averaging 33.18 % annually during periods when the S&P 500 price / peak earnings ratio was
below 15 and both 3 - month T - bill
yields and 10 -
year Treasury yields were
below their levels of 6 months earlier.
Still, we've observed diminishing returns from the Fed's interventions, there is no political tolerance for the Fed to intervene in securities involving any credit risk that would be borne by U.S. citizens (purchasing European sovereign debt, for example), and the
yield on the 10 -
year Treasury bond is already down to 1.7 %, which is far
below where it stood when prior interventions were initiated.
After today's turmoil, U.S. 10 -
Year Treasury yields are currently around 2.21 %, below where they started the y
Year Treasury yields are currently around 2.21 %,
below where they started the
yearyear.
But for the most part, the
yield on the benchmark 10 -
year Treasury has stayed
below 2 percent since late 2011.
If you sit back and ponder this situation for a minute, this helps to understand why mortgage interest rates aren't still shooting to the moon and why
Treasury yields have cooled during the past week or two, with the 10 -
year yield closing
below 2.75 % last week.
Based on the data
below, for each 1 % increase in the 10 -
year U.S.
Treasury yield, STORE capital's dividend
yield can be expected to rise by about 1.47 %, meaning the share price would be expected to decline (perhaps somewhat meaningfully) over the short - term.
The graph
below shows the performance of
Treasuries, equities and high
yield over the past
year.
Trade: Buy the 10 -
year US
Treasury note when real
yields are more than one standard deviation above the long - term moving average sell when they are more than one standard deviation
below.
Since 1962 the
yield on the U.S. 10 -
year Treasury note has explained roughly 25 % to 30 % of the variation in U.S. large cap equity multiples, as measured using the trailing price - to - earnings (P / E) ratio in the chart
below.
The graph
below shows the performance of
Treasuries, equities and high
yield over the past
year.
This graph from JP Morgan Asset Management's research team offers some optimism for equities for rolling two -
year periods if the Fed starts to raise while 10 - Year Treasury yields are still below
year periods if the Fed starts to raise while 10 -
Year Treasury yields are still below
Year Treasury yields are still
below 5 %.
The difference in
yield between two -
year and 10 -
year Treasuries recently fell
below 50 basis points (source: Bloomberg).
We also compared the five -
year annualized volatilities of the S&P Pan Asia Bond Index (denominated in USD) with other major bond markets, such as the U.S.
treasury, U.S. investment grade corporate, U.S. high
yield corporate, Eurozone sovereign and Australian bond markets, see the exhibit
below.
Given that, in mid-July,
yields on the 10 -
year Treasury note fell
below 3 % and
yields on the two -
year note were at a record low, I am not surprised by these requests.
The
yield on the 10 -
year Canadian government bond is 1.07 %, not far
below that of the 10 -
year U.S.
Treasury at 1.55 %, as Bloomberg data shows.
In the chart
below, high
yield's upside is best when OAS spreads are much higher than they are currently (3.85 %); prospects on 4 -
year forward excess return over
treasuries are relatively dismal when OAS spreads are as low as they are today.
One major unknown here is whether the
yield on the 10 -
year Treasury bond will fall
below the two -
year note.
On Monday, April 23, the markets continued their slide as the ten -
year Treasury yield settled just
below 3.0 %, in spite of the preliminary readings of the April manufacturing and services PMIs both showing increases and March existing home sales rising 1.1 %, beating analyst expectations.
Still, we've observed diminishing returns from the Fed's interventions, there is no political tolerance for the Fed to intervene in securities involving any credit risk that would be borne by U.S. citizens (purchasing European sovereign debt, for example), and the
yield on the 10 -
year Treasury bond is already down to 1.7 %, which is far
below where it stood when prior interventions were initiated.
When the 30
year Treasury yield has been
below its level of 6 months earlier, the XAU has advanced at an annualized rate of 19.17 %, compared to an annualized loss of -17.51 % when
Treasury yields have been rising.