Friday, August 18, 2023
- Yields have moved a little too much too fast for equity markets, pushing the correlation between stocks and 10-year Treasury yields into negative territory for the first time since March.
- From a technical perspective, 10-year Treasury yields remain uncomfortably high as they approach resistance from the October highs. Considering stocks bottomed nearly at the same time longer duration yields topped out last fall, a breakout to new highs on the 10-year would be a warning sign for a potentially deeper pullback in stocks.
- Energy could outperform if yields continue higher. The sector is the only one positively correlated to 10-year Treasury yields.
Treasury yields are beginning to resemble the popular Cliff Hanger game on the “Price is Right” television show—how high can they go before the game is over for equity markets? Considering stocks bottomed at nearly the same time longer duration yields topped out last fall (not a coincidence), a breakout to new highs on the 10-year would serve as a warning sign for a potentially deeper pullback in stocks. Furthermore, the correlation between stocks and 10-year yields turned negative last month, suggesting the recent advance in yields may be a little too much too fast for stocks to digest. The diverging paths have been especially apparent in the heavyweight and longer-duration technology sector, which may face additional valuation pressure if rates continue to rise.
How High Will They Go?
As shown below, 10-year Treasury yields have surpassed resistance at 4.09% and are now contending with the highs set last October. Technically, a move above 4.34% would qualify for a breakout.
While momentum remains bullish and further validated by the 50-day moving average (dma) crossing above the 200-dma, near-term upside pressure appears to be losing a little steam. The Relative Strength Index (RSI)—a momentum oscillator used to measure the speed and magnitude of price action—has registered a series of lower highs over the last few weeks. This negative divergence raises the question about the sustainability of upside momentum in yields.
In the event of a breakout, the next significant areas of resistance for yields set up near 4.50% (2006 lows) and 4.70% (prior mid-2000s highs).
If 10-year Treasury yields breakout to new highs, communication services, consumer staples, and technology could see outsized headwinds as they have been the most inversely correlated sectors to yields over the past year. Energy, which continues to gain technical traction and relative strength, could see further outperformance if yields advance.
Benchmark 10-year Treasury yields have rallied back toward their October highs. This area is not only a significant resistance level for yields but also an important level for stocks, as the equity bear market low closely overlapped with the highs set on the 10-year last fall. On a near-term basis, a negative divergence between yields and momentum has formed, raising the question of the sustainability of the recent upside in 10-year yields. If yields continue higher, energy could see further relative outperformance as it is the only sector positively correlated to 10-year Treasury yields. LPL’s Strategic and Tactical Asset Allocation Committee (STAAC) maintains its slight preference for fixed income over equities, mainly due to valuations, and would look for future stock market weakness for potential buying opportunities.
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