Additional Market Commentary
Breach of 3 percent yield on the 10-year U.S. Treasury bond is largely symbolic
Benchmark 10-year U.S. Treasury bond yields rose above the 3 percent level on April 24 and are now at the highest level since 2013. The 3 percent level coincides with a 32-year downtrend line. With higher yields, Treasuries have begun to offer more competition versus riskier assets, such as stocks, real estate and high yield bonds.
We view the move above 3 percent as largely symbolic for now, but believe a sustained move above the 3.25 percent to 3.5 percent range would likely foreshadow increasing challenges for stocks. For the time being, we advocate a balanced approach to risk within your long-term investment goals by rebalancing back to a more neutral stock and bond allocation. Within fixed income, we have moderated our exposures by taking a balanced approach to U.S. Treasuries versus riskier corporate bonds. Given our expectation for modestly higher bond yields, we prefer shorter-maturity bonds that have less sensitivity to changes in rates.
Bond yields are likely to rise further, albeit modestly
We have discussed our expectation for rising bond yields for a number of months. Key drivers are rising inflation and inflation expectations, stable to rising growth, ongoing rate hikes by the Federal Reserve, increased Treasury issuance and tapering net global central bank asset purchases. However, strong global demand for safe, income producing, long maturity investments may help keep the rise in interest rates contained.
A sustained trend of higher yields could be negative for stocks
When Treasury yields rise, not only do they compete with other risky assets, such as stocks, real estate and high yield bonds, but the value of those other assets can be eroded when using commonly accepted valuation techniques. Year to date, the rise in 10-year Treasury yields from 2.4 percent to 3 percent has placed intense pressure on a number of rate sensitive sectors of the stock market. Within the S&P 500, the Utilities, Telecom, Consumer Staples and Real Estate sectors are down 4.5 percent to 12 percent on a year-to-date basis. If Treasury yields continue to rise, pressure on stocks, particularly rate-sensitive stocks, is likely to persist.
Fixed income remains a necessary component of most well-diversified portfolios
In our view, bonds continue to serve as a fundamental component of well-diversified portfolios. We prefer shorter maturity bonds due to their reduced sensitivity to rate changes. With the two-year Treasury yield near 2.5 percent and the three-year near 2.65 percent, low-risk Treasuries now offer a higher yield than the dividends of the S&P 500. If longer-dated U.S. Treasuries continue to rise, our preference for Treasuries may increase or we may prefer bonds with longer maturities. We see the risk/reward of Treasuries versus investment grade corporate bonds as balanced.
We believe the rise in the 10-year U.S. Treasury yield above 3 percent is largely symbolic, but a sustained move higher could prove difficult for stocks. While we expect modestly higher rates, the move is likely to be contained by strong investor demand for safe, income-producing assets. We advocate for a balanced approach to risk within well-diversified portfolios and prefer bonds that have less interest rate sensitivity for now.
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This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. Any organizations mentioned in this commentary are not affiliated or associated with U.S. Bank in any way.
Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.
Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes mentioned are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general.
Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Investment in debt securities typically decrease in value when interest rates rise. The risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults).