The 10-year yield is marching higher, hitting a 2015 high of 2.38 percent. And if yields keep rising, it could soon mean big trouble for stocks.
"The 10-year has gone from 1.65 up to, say 2.30" in the past four months, said Larry McDonald head of U.S. strategy at Societe Generale. "If we move from 2.30 up to 2.75 in a very short period of time, that is definitely the pain point, because the market can't take that type of move in a very short period of time."
As McDonald sees it, market valuations will look exceedingly rich if yields move much higher. Since investors make allocation decisions by comparing the returns of different asset classes, higher rates will make bonds a better alternative to stocks, reducing demand for equities.
On top of that, McDonald says that higher yields will have a deleterious effect on the fundamentals of many companies.
"In the S&P, 45 percent of profits in the last five years are because of financial engineering and because of low interest rates. So you have a lot of companies offering a lot of very cheap debt, and that's very profitable for those companies, " McDonald said in a Wednesday "Trading Nation " interview.
Erin Gibbs, equity chief investment officer at S&P Capital IQ, agrees with McDonald about the sort of bond market move that would cause trouble for stocks.
"When it really comes down to it, we see investors shifting asset classes when there's a real fear of recession, and that's when they get out of stocks. So we look at interest rates and say, 'what type of interest rate rise would we need to see where people would become concerned about the U.S. economy?'"
"For us, we see similar levels to what Larry was saying, or about another 50 or 100 basis points from here, very rapidly," Gibbs said Wednesday, also on "Trading Nation."
If yields quickly surge another 0.5 percent to 1 percent, "that would make people concerned about wage growth, creating jobs, and so on—which would then relate to [concerns about] a recession, worrying about the stock market and pulling out."
Of course, given that three of the 10 S&P sectors (telecom, utilities and energy) currently offer a dividend yield greater than 2.9 percent, there may still be a strong case for stocks even if rates jump by another half a percentage point.
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