Is High Treasury yield a bullish signal to stock market?

Question

Conventionally, when 10Y T yield is up, investors run away from growth stock, and vice versa, as it affect the risk free rate, and caused changes to their DCF model.

I am here trying to breakdown the logic in it.

First, if 10Y T yield is up, is because it's bond price is down;

Because investors are selling bond;

This decision assume investors have better options at somewhere else, with lesser risk/better return;

Could it be 2Y Treasury? But the yield is raising too, caused by selling of bond. So, there are even better investment else where?

Could it be gold? Yes, gold did tick up a little, but "value" stock like BRK did several ATH during high Treasury yield period.

Could this mean, Treasury yield mainly affect the rotary between growth stock and value stock? And the market is in fact still bullish on equity, just towards lower valuation companies?

Answer 1

Yields down = Bond prices up: usually, Bonds are considered a safe-heaven asset, so a bid in bonds signals flight to safety: so when yields drop sharply without any specific central bank action, it's a bearish signal for stocks.

Likewise, when yields go up, it normally means that investors are selling bonds and are happy to allocate their cash into riskier assets, such as stocks: so increasing yields can be a bullish signal for stocks.

However, it's not as straight-forward as: yields up = stocks up, yields down = stocks down. For example, what we're seeing now is a sharp increase in yields because the FED is gradually signalling to markets that they are prepared to raise the central bank rate in order to fight inflation. The FED have also been running Quantitative Easing, which in practice means that they have been purchasing bonds, artificially supressing their yields. The FED has also signalled that they will "taper" their bond purchases, which also causes bond yields to increase.

Inflation is generally bad for stocks, and as you point out, high central bank rates are also bad for stocks because of the discounted cashflow model. However, having said that, the S&P 500 is now at 4,600, which is very near to all-time-high, even though yields have been increasing recently. So it's not as straightforward. In my opinion, so much money has been printed by the FED since 2008 that it's just difficult for the stock market to sell off, because investors have too much cash lying around and they need stocks to invest that cash somewhere, particularly as bonds prices are under pressure.

So in conclusion, I'd say that whether yields are a bullish or a bearish signal for stocks depends on the context. When bond yields drop without the central bank signalling that it will cut rates, it is usually a bearish signal. Likewise, if yields rise without the central bank signalling that it will increase rates, it is a bullish signal.

But if the drop or rise in yields is related to central bank policy, it's not easy to say whether it's bullish or bearish for stocks. Depends on many other factors, including how much cash is in the system (M2 money supply) and a number of other factors.