Interest rate storm resurfaces, equity duel begins a new chapter

According to Jeff Johnson, head of fixed income products at Vanguard Group (Vanguard), the current level of yield makes bonds a “very powerful insurance strategy” in the portfolio.

As interest rates in the bond market rose, the stock market came under pressure. Investors are waiting for the upcoming US employment data report and Wall Street Bank's earnings season to begin.

“Stocks are once again becoming sensitive to interest rates,” Morgan Stanley stock strategist Mike Wilson said in a report Monday. “Interest rates are The most important observed variables in early 2025. ”

The 10-year US Treasury yield climbed sharply over the past month, slightly above 4.6% on Monday. Meanwhile, the S&P 500 has been weak over the past month.

Given the current relatively high valuation of the S&P 500, some investors are concerned that rising interest rates could hit the US stock market. The continued rebound of the S&P 500 index will depend in part on the company's earnings growth. J.P. Morgan Chase (JPM.N) will announce its fourth quarter earnings report and guidance next week, while upcoming macroeconomic data may drive bond interest rate fluctuations.

“We're relatively cautious about interest rates,” Facet's chief investment officer Tom Graff said in a phone interview. He believes that as long as inflation remains generally manageable, there is no need to worry about 10-year Treasury yields drifting to 4.8%-5%.

Graff notes that the stock market is more likely to accept higher interest rates when the economy is strong and inflation is under control, rather than seeing lower interest rates in a “mediocre economy.” But he also warned that if interest rates rise due to inflationary pressure, it may cause fluctuations in the stock market.

Investors will get December's Consumer Price Index (CPI) readings on January 15, while the latest US jobs report will be released on Friday.

Meanwhile, Wilson notes that the correlation between stock returns and bond yields has clearly turned negative (yields rise, stocks fall, and vice versa), the first time since last summer.

He added that to see the return of the “good is good” market background, where improved economic data can drive stocks up even when interest rates rise, stronger evidence is needed that market sentiment is improving and translating into stronger economic activity. “If growth is not supported by this dynamic and inflation remains stubborn, the negative correlation in stock returns/bond yields is likely to continue. ”

The 10-year Treasury yield surpassed 4.5% in December of last year, leading to a narrowing in the breadth of the US stock market. Wilson notes that this “caused the stock market to end in a weak performance in an otherwise excellent year. ”

According to FactSet data, the S&P 500 has increased by more than 20% each year over the past two years. The index rose 23.3% in 2024, compared to 24.2% in 2023.

Pioneer Group's Jeff Johnson said that in the long run, the stock market's return over the next 10 years is likely to be similar to that of fixed income .

He pointed out that the valuation of US stocks appears to be “too high,” and that today's higher yields “cushion future bond returns .”

“Bonds provide a 'very powerful insurance strategy' for the possibility of stock valuations being normalized or stocks underperforming,” Johnson said. “We I think the future fixed income environment looks quite favorable. ”

Pioneer Group predicts that the annualized return on US composite bonds over the next 10 years will be 4.5% to 4.5%, while the expected increase in US stocks is between 3% and 5%.

The 10-year Treasury yield rose two basis points to 4.616% on Monday , from 52 on April 25, 2024 The weekly high was 9 basis points lower. There is an inverse relationship between bond yield and price.

“It's very difficult to consistently predict interest rate changes in the short term and accurately grasp this in the portfolio,” Johnson said. “Even if interest rates rise, high yields may bring greater benefits to investors with a medium- to long-term investment perspective. ”

Pioneer Group's US investment-grade bond market passively tracking ETF had a total return of 1.4% last year, while actively managed Pioneer Core Enhanced Bond ETFs performed better , with a total return of 2024 2.7%

Graff believes the stock market is trading in an “information vacuum” while awaiting fourth-quarter earnings reports, new data on employment and inflation, and news that President-elect Trump will return to the White House on January 20.

Meanwhile, Wilson advises investors to keep choosing quality stocks. “The recent rise in interest rates provides another reason to choose high-quality stocks — companies with stronger balance sheets and lower leverage may still be less sensitive to interest rates,” he said.