Broker Check

Bond yields have been on a mini-surge this week.

September 28, 2021
Share |

Bond yields have been on a mini-surge this week. The current yield on the 10-year Treasury suggests it can rise even more in the short-term, making cyclical stocks look like good bets. The 10-year yield rose to 1.46% on Friday from a low point of 1.3% last week. It passed 1.38% this week, a key level of support at which buyers had tended to step in for the past few months. Bond prices and yields move inversely. The yield on the 10 year Treasury was .7% last May and move up to 1.7% at the beginning of this year before dropping to 1.3%. 

Signs point to a continued climb for the 10-year yield. Bay Crest Partners’ chief market technician, Jonathan Krinsky, writes that the 10-year yield looks to be headed to 1.6%. With the yield pushing above 1.38% and breaking out of its six-month downtrend, he writes, it looks like “a new trading range is underway.” The 10-year yield was trading at 1.485% in early Monday trading.

Why is this important that we follow the growth of the 10-year yield? If the 10-year yield approaches 2.2%, many economists think that is a value that will indicate that the stock market is fairly valued. That does not mean the market is overvalued. It just means that when compared to interest rates stocks are now competing for dollars with bonds.

Of course, many central banks around the globe have signaled confidence in the economy. The Federal Reserve has suggested that the reduction of its bond-buying program - a pillar of economic support since the pandemic began - could come as soon as November. This indicates that the Fed is comfortable that the economy can grow without its help. 

Market-based inflation expectations for the next 10 years currently stand at 2.34%, according to St. Louis Fed data, another reason the 10-year Treasury yield likely could edge up further. Small-cap companies can especially benefit in this environment. Those firms’ earnings typically rely much more heavily on growth in the domestic economy, and they have better access to capital when the economy is growing. Regardless of size, companies in economically sensitive sectors—such as banking and oil—can benefit, too.

Since the 10-year yield began surging this past week, the Russell 2000 index of small-cap stocks has risen 3%, outpacing the S&P 500’s 2.2% gain. Cyclical sectors on the S&P 500 have also beaten the broader index. However, too fast a rise in bond yields could dent all stocks, though the most economically sensitive ones could still outperform. 

As I have said often, the 10-year Treasury is a key indicator of valuation in stocks. I will keep you abreast of this key indicator. For now, we are well-positioned to take advantage of any market move up. 

Right now, the consensus among economists is that nonfarm payrolls grew 513,000 in September, while the unemployment rate dropped to 5.0% from 5.2%. So, for all we know, the current consensus might be exactly right. After all, payrolls are up 503,000 per month in the past year and up 586,000 per month so far in 2021, so what the consensus is forecasting is more of the same. 

But what the consensus seems to be overlooking is that the national system of overly generous unemployment benefits that had been in effect since COVID-19 hit the US, ran out on Labor Day weekend. As a result, many unemployed people who had previously been getting payments above what they could have earned while working are no longer able to do so.

I think this should translate into a major surge in job growth in September or October, and think there is enormous upside potential for the next two jobs reports. No one should be surprised if one of those reports shows as much as two million net new jobs. Seriously!

Keep in mind that not all of these jobs have to be real job creation; much of it could be workers who were being paid "under the table" to preserve their unusually high jobless benefits moving back toward regular "on the books" employment. 

Yes, I am well aware that some news outlets have published stories about the states that curtailed extra jobless benefits earlier in the summer not getting extra job creation, but this analysis was very weak. For example, it failed to control for other factors, like the extra COVID cases/hospitalizations that many of these states had this summer. Nor did they control for the smaller remaining pool of available labor in these states. In addition, the rollout of the child credit may have temporarily dampened job creation nationally.

The US economy is far from fully healed from the COVID-19 disaster. But now that the government has stepped back from extra large payments to the unemployed, we think the labor market is on the verge of a big step forward. That bodes well for stocks while interest rates are rising. Expect an end-of-year move up. 

"This material is provided for general information and is subject to change without notice.  Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. The information does not represent, warrant or imply that services, strategies or methods of analysis offered can or will predict future results, identify market tops or bottoms or insulate investors from losses. Past performance is not a guarantee of future results.  Investors should always consult their financial advisor before acting on any information contained in this newsletter.  The information provided is for illustrative purposes only.  The opinions expressed are those of the author(s) and not necessarily those of Geneos Wealth Management, Inc."