Don’t Fret Rising Rates

Stoking fear, US 10-year Treasury yields hit 4.8% this week, their highest since ... October 2023.^[i] Now, those who remember then may wish to point out October 2023 wasn’t exactly an awful point to own or buy stocks, but nevertheless, worries are rising. And, while America’s rates are higher than in the rest of the developed world (except the UK), a similar dynamic holds globally. Rates may be up—and weighing on sentiment—but nothing about it seems fundamentally game changing for stocks.

What has folks so alarmed? Loads of people think rising yields will draw investors away from stocks, considering there is theoretically less compensation for their higher volatility. If true, stocks and yields should have a reliable negative correlation that stretches back further than the last handful of trading days. Problem is ... they don’t. Consider the historical weekly correlation between 10-year Treasury yields’ movements and the S&P 500’s. A correlation of 1.00 means they move in lockstep and -1.00 exactly opposite. Since May Day 1953 (when weekly data begin) through last Friday, it was 0.07.^[ii] Their correlation basically rounds to zero—there isn’t any. That means yields rise and fall together about as often as they diverge.

Those warning about rising rates also allege the S&P 500’s “equity risk premium” (ERP) shows stock valuations are unfavorable versus Treasurys. There are different ways to measure ERPs, but one popular method is to use the gap between the S&P 500’s earnings yield—the inverse of its price-to-earnings (P/E) ratio or E/P—and the 10-year Treasury yield. As many point out, it has turned negative for the first time since 2009. Sound scary? History’s longest bull market began that year. This shouldn’t be surprising. Rates don’t drive stocks—and ERPs remain unpredictive.

As Exhibit 1 shows, Treasury yields have often topped earnings yields. Then Exhibit 2 shows a big ERP didn’t prevent past bear markets, and negative ERPs don’t preclude bull markets—see almost the entirety of the 1990s. Furthermore, ERPs have been negative in this cycle since August 2023. Over that span, the S&P 500 has returned 34.6%.^[iii] ERPs may tell you whether it is profitable for companies to borrow to finance stock buybacks or M&A, but that is about it. It is pretty clear they don’t forecast market direction.

Exhibit 1: Stocks’ Earnings Yield Versus 10-Year Treasurys’

Source: Multpl.com, as of 1/16/2025. S&P 500 earnings yield and 10-year Treasury yield, monthly, January 1996 – December 2024 (and latest daily data as of 1/15/2025).

Exhibit 2: ERP Going Negative Doesn’t Matter

Source: Multpl.com, as of 1/16/2025. S&P 500 earnings yield minus 10-year Treasury yield, monthly, January 1926 – December 2024 (and latest daily data as of 1/15/2025).

In our view, it is also a potential error to presume the recent rate rise extends for long. We suspect it is mostly tied to swinging sentiment related to deficit concerns and inflation fears. Fundamentally, we see little to warrant a sustained move higher. Inflation and inflation expectations are long-term Treasury yields’ main driver. As yesterday’s CPI report highlighted, inflation continues easing (if irregularly) back to prepandemic trends. Cool money supply growth suggests that trend should persist. Meanwhile, the US remains just as creditworthy as a month ago—and for the foreseeable future, with government revenues dwarfing interest payments by more than five times.^[iv]

Similar worries drove 10-year yields to 5.0% in October 2023 and 4.7% April 2024—only to reverse fast as sentiment swung again.^[v] We can’t say if 10-year yields’ retreat back under 4.7% Wednesday will persist.^[vi] As with stocks, bond volatility is inherently unpredictable (though typically less pronounced). But absent anything fundamental—and surprising—sentiment and volatility swings aren’t anything to sweat. And, whatever rates do, remember: They don’t dictate to stocks.