The US bond yield “breaking 5” tests the success of corporate profits, but Xiaomo is unmoved: stocks will still be the engine of portfolio growth

The Zhitong Finance App learned that recently, US long-term treasury bonds were sold off again, and the 10-year US bond yield exceeded 5%, the highest level since 2007. As an important anchor in global risk asset pricing, this change is redefining the relative appeal of stocks and bonds. However, J.P. Morgan strategist Grace Peters (Grace Peters) said that even if rising bond yields are raising the threshold for profit growth, stocks are expected to continue to rise.

Why 5% affects the market: the double test of stocks and bonds

On Thursday, the sell-off in the bond market deepened. The yield on the US government's longest term treasury bonds rose to the highest level in more than 20 years. The yield on 10-year US bonds was at a level not seen since July 2007, and European yields also rose at the same time.

The 10-year US Treasury yield affects the global market not only because it represents the US government's financing costs, but also because it is a key risk-free interest rate benchmark in stock and bond valuation models. Peters attributed the upward trend in bond yields in this round to three aspects: strong growth data, the supply of new bonds entering the market to finance artificial intelligence (AI) infrastructure, and concerns about inflation caused by oil prices above $100 per barrel. If these macro headwinds do not subside, the 10-year yield will remain stubbornly high. This is generally bad for stocks, and a double-edged sword for bonds.

When the 10-year US Treasury yield rises above 5%, it is more attractive as a safe and more profitable income investment than most dividend stocks and ETFs. The S&P 500 composite dividend rate is only about 1%, while the US dividend stock ETF-Schwab (SCHD.US) has had a dividend rate of about 3% over the past 12 months. Many yield investors may sell stocks and switch to short-term treasury notes.

Meanwhile, many high-growth stocks are still trading at premium valuations. In a low interest rate environment, investors are willing to pay a premium for future growth, and companies can easily borrow and expand; however, rising interest rates will reduce valuations, push investors to more conservative assets, and push up borrowing costs. As a result, rising treasury bond yields usually present a headwind for overvalued growth technology stocks.

It is also difficult to stand alone in the bond market. Higher treasury yields make newly issued government bonds more attractive to yield investors. In order to keep up with US bonds, corporate bonds also need to be issued at higher yields to attract more attention. However, the market price of old bonds issued at lower interest rates will fall as higher-yield bonds enter the market.

For example, the face value of a bond previously issued with a 3% coupon may drop from $1.00 to $0.80 per dollar as interest rates rise. For long-term investors, this temporary decline is unimportant as $1.00 per dollar will still be recovered from holding to maturity; however, short-term traders who plan to sell before expiration will be under pressure. Higher interest rates and treasury yields hurt bonds less than stocks, but they still depreciate old bonds and push investors to switch to new high-yield bonds.

Why does J.P. Morgan still keep bullish on stocks

In the context of high yields, Peters believes that fixed income still has allocation value in the investment portfolio, but it must be carefully selected; however, in comparison, she is more optimistic about stocks and expects the market to usher in a “profit supercycle that continues to expand in scope.” “Our belief is indeed in stocks, which will be the growth engine of the portfolio.”

She pointed out that the stock market did not take rising yields lightly. The 10-year US Treasury yield has changed by about 40 basis points this month. “This is not enough to actually stir up two standard level fluctuations in the stock market, but the stock market will obviously remain alert, and I think they have absorbed a large part of it.”

Peters anticipates that the currently high profit expectations will be fulfilled and may be further revised when looking ahead to 2027. She recommended that investors focus on companies that have pricing power and high visibility into profit streams.