Stocks surged to new highs last week, fully erasing losses caused by the U.S.-Iran war, but the bond market could spoil the party.
The S&P 500, a benchmark for U.S. market performance, finished Friday’s sessions at a record level and was up about 5% from its pre-conflict level through Friday. In contrast, the Treasury market, evidenced by the Bloomberg Treasury Index, was down 1.7% compared with pre-conflict levels.
The Treasury market is at a critical juncture and deepening losses at this point could pull money away from stocks as prices fall and yields rise.
How? Look at the popular iShares 20+ Year Treasury Bond ETF. At the current price of $84.80, the long-term Treasury fund is approaching $83.30, its lowest point over the past year. This is called a ‘floor,’ a support level where buying demand has been strong enough in the past to halt a downtrend.
A break below $83.30 would bring the next intraday low of $83.24, set on Oct. 30, 2023, into the picture. A breach of these levels would mean the fund is essentially entering a vacuum, a space from where strategists would start expecting recovery.
This same turning point is visible in Treasury yields. For a 10-year bond, the yield is at 4.444%. The market is on watch for a move toward 4.5%. The last time the 10-year bond yielded above 4.5% was on June 11.
Debt that matures in 30 years now yields 5.006%. The last two times it crossed the key threshold of 5% was on April 30 and in July of last year.
“These are key levels of overhead resistance [in yields], which if broken can cause a deeper sell off in bonds” wrote Roth Chief Market Technician JC O’Hara.
Treasuries are trending toward offering an attractive coupon payment, potentially making them more attractive than stocks. At the same time, lower prices create an attractive entry point for investors to rotate money into Treasuries from stocks, which have long been considered expensive.
Investors, as of Thursday, were paying 21.04 times the projected next 12 months profit of U.S. companies compared with the 10-year and 20-year average multiple of 19.3 times and 16.6 times, respectively. The market has gotten expensive since the pandemic as stocks of tech giants have come to dominate the index.
The Magnificent Seven group of large technology stocks—Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla—make up 36.5% of the index.
“The wildcard is the ability of risk assets to retain current lofty valuations with persistently elevated Treasury yields,” wrote Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets. “Prior episodes indicate that 10-year rates >4.50% and 30s >5.00% are likely to at least bring yields into conversations in other markets, if not be responsible for a bearish repricing.”
“For the time being, stocks appear content to forge toward fresh record highs as earnings season has left investors with enough confidence to chase prices higher,” he added.
Earnings growth is on track to accelerate to 24.6% in the first quarter, the highest in at least 4 years, according to Deutsche Bank estimates. Fourth-quarter earnings growth was 13.4%.
Write to Karishma Vanjani at karishma.vanjani@dowjones.com.
