Since 1981, Treasury yields have pretty much gone in just one direction: down.
The result has been one of the most awe-inspiring bull markets in the modern era — one spanning more than three decades.
But the party may be over for Treasury bulls, who profit from lower yields because of the inverse relationship they have with bond prices. This can be seen in the 10-year Treasury yield, which bounced off a record low in 2016 and has recently shown signs of a sustained move higher.
Macquarie, for one, thinks the bond market’s stretch of strength is in its final innings. The firm forecasts the 10-year yield — currently trading just above 3%— will approach 4% over the next 18 months.
Many Wall Street experts have highlighted such an increase as problematic to the continued health of the stock market, which is locked in a historically long bull market of its own. The thinking is that as bonds get more appealing, stocks will lose luster by comparison.
To make the situation even more ominous, the majority of investors aren’t old enough to remember the last time Treasury yields were climbing, which could leave them unprepared for the fallout. After all, once you’ve become so accustomed to one set of circumstances, it can be tough to break free from conventional thinking.
“Most market participants have only ever seen yields move lower during their working lives,” a group of Macquarie strategists led by Ric Deverell wrote in a client note. “While the outlook for interest rates is highly uncertain, we feel that the bull market is over. The increase will be driven by the slow withdrawal of central bank financial repression and an increase in estimates of the real neutral rate as the long tail of the crisis begins to fade.”
Macquarie isn’t alone in its concern. Morgan Stanley says that three months after Treasury yields peak, stocks do the same, which means it’s all downhill from there. The firm even made the preemptive move of cutting its net equity exposure in half.
Bank of America Merrill Lynch has weighed in as well, arguing that a Treasury yield move above 3.6% will spur a massive reallocation from stocks into bonds. It’s part of a broader concern floated by the firm pertaining to investor cash levels. BAML predicts widespread weakness in risk assets once cash holdings drop below where they are now — and pressure from yields represents one of multiple factors that could complicate matters.
A separate analysis from BAML shows stocks may be already losing their luster relative to Treasurys with nearer-term maturities. This past week, the 3-year Treasury yield (1.90%) rose above the benchmark S&P 500‘s dividend yield (1.89%) for the first time since 2008 (see below).
In other words, holding money in safe, cash-like assets like Treasurys is now a competitive alternative to stocks for the first time since the financial crisis.
All of the factors outlined above would seem to suggest an imminent reckoning in stocks. At the very least, they should offer a wake-up call for equity investors who have become so accustomed to easy returns.
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