US bond yields are pushing higher, as are warnings about a looming US stock market correction.
On Monday, the US 10-year treasury yield hit 2.73%, the highest level since April 2014. 2-year treasury yields — reflecting growing expectations that the US Federal Reserve will continue to lift interest rates — also increased, rising to 2.16%, a level not seen since September 2008.
The lift in yields across the curve certainly caught the attention of stock investors, contributing to losses of 0.7% for the Dow Jones Industrial Average and the S&P 500.
After the strongest start to a year in at least 30 years, and the longest period without a 5% pullback on record, according to analysis from Goldman Sachs, it’s understandably caused some angst among investors.
But should it?
To John Higgins, economist at Capital Economics, it shouldn’t, at least not yet.
Pointing to the chart below, Higgins says “it is quite common for interest rates, government bond yields and equity prices to rise at the same time”, adding the caveat that it usually requires investors to have a “growing appetite for risk and a positive view of corporate earnings”.
Higgins’ optimism towards corporate earnings likely explains why US stocks have jumped out of the gates this year, adding around 5% in January alone.
“This expectation has been shaped by tax reform, a healthy global economy, and a weaker US dollar,” he says, adding that investors believe “growth in earnings will be faster in the future”.
While no one knows whether a market pullback will arrive near term as a result of higher bond yields, Higgins says there’s unlikely to be a substantial correction until expectations for corporate earnings growth reverse.
“Once growth has started to slow, expectations for earnings have fallen and investors have become more cautious,” he says.
“The stock market has peaked and then fallen sharply.”
Higgins says we’re not at that point yet, although he warns that such a scenario could arrive later this year.
“We suspect that signs of an economic slowdown will become apparent later this year, setting the stage for a significant correction in the S&P 500 before the end of 2019,” he says.
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