Rising Treasury yields could provide the latest test for a rally that has made U.S. stocks increasingly expensive while taking them to fresh record highs.
So far, a resilient economy, robust corporate earnings and excitement over artificial intelligence have helped stocks largely shrug off rising yields this year. Some investors worry, however, that elevated valuations could make equities more vulnerable if rates keep climbing. Besides raising the cost of capital for companies and households, higher yields can increase the appeal of “risk-free” Treasury bonds compared to equities.
One key reason investors have been more sanguine about rising yields this year is the Fed, which has signaled it intends to cut rates in 2024. But strong economic data has made investors doubt the central bank will be able to ease rates as much previously expected. Some investors believe a pullback is overdue. The S&P 500 has not fallen significantly since October, though retreats of 5% or more historically occur three times a year on average, Bank of America Global Research data showed.
If yields are rising “because growth has been a lot stronger than expected, then investors will be OK with that,” said Damian McIntyre, head of multi-asset solutions at Federated Hermes. “But if growth starts to slow and inflation is climbing then that will start to weigh on investors’ minds.”
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