Rising Rates Don’t Dictate to Stocks

Stoking alarm amongst commentators we follow, 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 global stocks, but nevertheless, warnings are rising. And, whilst America’s rates are higher than in the rest of the developed world (except the UK), a similar dynamic holds globally.^[ii] Rates may be up—and weighing on sentiment—but, to us, nothing about it seems fundamentally game changing for stocks.

What has folks so alarmed? Loads of people we observe warn rising yields will draw investors away from stocks, considering there is theoretically less compensation for their higher volatility. If true, stocks and yields would have a reliable negative correlation that stretches back further than the last handful of trading days, in our view. Problem is ... they don’t. Consider the historical weekly correlation between America’s 10-year Treasury yield 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 Friday, it was 0.07.^[iii] Their correlation basically rounds to zero—which means there isn’t any. Yields rise and fall together about as often as they diverge.

Those we find warning about rising rates also allege the S&P 500’s equity risk premium (ERP) shows stock valuations are unfavourable versus US 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—a stock’s or index’s per-share earnings divided by its share price (the earnings yield or inverse of the price-to-earnings ratio)—and the 10-year Treasury yield. As many reports we read point out, it has turned negative for the first time since 2009. Sound scary? History’s longest US bull market began that year.^[iv] We don’t think this should be surprising. Our research shows rates don’t drive stocks—and valuations remain unpredictive.

As Exhibit 1 demonstrates, 10-year US Treasury yields have often topped S&P 500 earnings yields. Then Exhibit 2 shows a big ERP didn’t prevent past bear markets (typically prolonged, fundamentally driven declines exceeding -20%), and negative ERPs don’t preclude bull markets (periods of broadly rising equities)—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 34.3%.^[v] ERPs may tell you whether it is profitable for companies to borrow to finance stock buybacks or mergers and acquisitions, but that is about it, in our view. We think it is pretty clear they don’t forecast market direction.

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

Source: Multpl.com, as of 17/1/2025. S&P 500 earnings yield and 10-year Treasury yield, monthly, January 1996 – December 2024 (and latest daily data as of 16/1/2025).

Exhibit 2: ERP Going Negative Isn’t Alarming

Source: Multpl.com, as of 17/1/2025. S&P 500 earnings yield minus 10-year Treasury yield, monthly, January 1926 – December 2024 (and latest daily data as of 16/1/2025).

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 US deficit warnings, Britain’s budget debate and alarm over inflation (economywide price increases). Fundamentally, we see little to warrant a sustained move higher. Our research shows inflation and inflation expectations are long-term Treasury yields’ main driver. As Wednesday’s US consumer price index (CPI) report highlighted, inflation continues easing (if irregularly) back to prepandemic trends.^[vi] Cool money supply growth suggests that trend should persist.^[vii] Meanwhile, we find the US remains just as creditworthy as a month ago—and likely for the foreseeable future, with America’s government revenues dwarfing interest payments by more than five times.^[viii]

Similar issues drove 10-year yields to 5.0% in October 2023 and 4.7% April 2024—only to reverse fast as sentiment swung again.^[ix] We can’t say if 10-year yields’ retreat back under 4.7% Wednesday will persist.^[x] As with stocks, bond volatility is inherently unpredictable (though typically less pronounced) based on our analysis. But absent anything fundamental—and surprising—we don’t think sentiment and volatility swings are anything to sweat, as whatever rates do, they don’t dictate to stocks.