Bond yields are moving higher again, adding to concerns among equity investors already looking upon trade tariffs, high stock valuations and an aging bull market with some trepidation. Should investors brace themselves for market turbulence?
The yield on the 10-year U.S. Treasury bond rose above 3.09 per cent on Tuesday, marking a sharp rise from about 2.8 per cent in late August and putting the yield close to its previous seven-year high of 3.11 per cent in May.
Canadian bonds are also moving. The 10-year Government of Canada bond yielded 2.46 per cent on Tuesday, nearing its high of 2.52 per cent in May.
The sharp rise in yields come as U.S. employers continue to hire, inflationary pressures (such as wages) build and some officials in the U.S. Federal Reserve discuss how the central bank can hike interest rates without slowing the economy.
“For the first time since at least 2000, there are now more job openings than there are people unemployed. For reference, this ratio was closer to seven job seekers per job opening following the recession,” David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates, said in a note.
It sounds good. But rising bond yields can weigh on stock valuations. Dividend-paying stocks, in particular, look less attractive relative to the yields that investors can get on bonds and even guaranteed investment certificates.
Just look at what happened earlier this year when bonds took a leadership role.
The yield on the 10-year U.S. Treasury bond rose from 2.4 per cent in January to its high in May. Along the way, the S&P 500 fell more than 10 per cent. Even though the index has since recovered from this downturn, rate-sensitive stocks continue to struggle. Utilities are down more than 1 per cent year-to-date, underperforming the benchmark index by 10.3 percentage points. Telecom stocks are down more than 4 per cent.
Canadian rate-sensitive stocks have a worse year-to-date performance, demonstrating how rising U.S. bond yields can easily hop borders. Canadian utilities are down more than 11 per cent this year and telecom stocks are down 6.6 per cent, trailing the drifting S&P/TSX Composite Index.
You can see why by scanning some of the current offerings on GICs, near-cash investments whose yields have been following bonds. Although most of the big banks are still quite stingy, smaller financial institutions are luring investors with yields of more than 3 per cent for five-year GICs, according to ratehub.ca. Oaken Financial is offering 3.6 per cent and Tangerine (a unit of Bank of Nova Scotia) is offering 3.1 per cent.
Even one-year GICs beckon investors who don’t want to commit to a five-year period. Meridian Credit Union pays 3.25 per cent (for new deposits) and Simplii Financial (a unit of Canadian Imperial Bank of Commerce) pays 2.5 per cent.
That might look puny next to the S&P 500’s recent run. The benchmark U.S. index has returned 19 per cent over the past year and 91 per cent over the past five years, with dividends.
But this is looking backward. Ahead, there are concerns that might divert investor dollars away from the stock market. The U.S. administration slapped duties on US$200-billion worth of Chinese goods this week, and China retaliated with duties on US$60-billion worth of U.S. exports.
We don’t know what impact these tariffs will have, but some observers are sounding cautious given that S&P 500 stocks trade at more than 21 times earnings, which is close to a nine-year high.
“If one had to make an educated guess on the catalyst for a valuation correction" – where stocks trade at lower price-to-earnings ratios – “the most likely is ‘a trade war,’ ” Ian de Verteuil, an analyst at CIBC World Markets, said in a note this week. He added: "We think investors should gradually be raising cash from both equity and bond positions.”
The nice part: As bond yields rise, safe alternatives to stocks are looking more appealling.