In This Article:
By Lewis Krauskopf
NEW YORK (Reuters) - A hawkish turn by the Federal Reserve is eroding a key support for U.S. stocks, as real yields climb into positive territory for the first time in two years.
Yields on the 10-year Treasury Inflation-Protected Securities (TIPS) - also known as real yields because they subtract projected inflation from the nominal yield on Treasury securities - had been in negative territory since March 2020, when the Federal Reserve slashed interest rates to near zero. That changed on Tuesday, when real yields ticked above zero.
Negative real yields have meant that an investor would have lost money on an annualized basis when buying a 10-year Treasury note, adjusted for inflation. That dynamic has helped divert money from U.S. government bonds and into a broad spectrum of comparatively riskier assets, including stocks, helping the S&P 500 more than double from its post-pandemic low.
Anticipation of tighter monetary policy, however, is pushing yields higher and may dent the luster of stocks in comparison to Treasuries, which are viewed as much less risky since they are backed by the U.S. government. Graphic: Real yields turn positive, https://graphics.reuters.com/USA-STOCKS/YIELDS/xmvjoyogqpr/chart.png
On Tuesday, stocks shrugged off the rise in yields, with the S&P 500 ending up 1.6% on the day. Still, the S&P 500 is down 6.4% this year, while the yield on the 10-year TIPS has climbed more than 100 basis points.
"Real 10-year yields are the risk-free alternative to owning stocks," said Barry Bannister, chief equity strategist at Stifel. "As real yield rises, at the margin it makes stocks less attractive."
One key factor influenced by yields is the equity risk premium, which measures how much investors expect to be compensated for owning stocks over government bonds.
Rising yields have helped result in the measure standing at its lowest level since 2010, Truist Advisory Services said in a note last week.
Graphic: Equity risk premium shrinking, https://graphics.reuters.com/USA-STOCKS/REALYIELDS/znvneqyljpl/chart.png HEADWIND TO GROWTH SHARES
Higher yields in particular dull the allure of companies in technology and other high-growth sectors, with those companies' cash flows often more weighted in the future and diminished when discounted at higher rates.
That may be bad news for the broader market. The heavy presence of tech and other growth stocks in the S&P 500 means the index's overall expected dividends are weighted in the future at close to their highest level ever, according to BofA Global Research. Five massive, high-growth stocks, for example, now make up 22% of the weight of the S&P 500.