The 10-year Treasury yield is heading toward 2% and that could mean trouble for stocks

Published Tue, Feb 8 20226:37 AM ESTUpdated Tue, Feb 8 20229:08 AM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

The 10-year Treasury yield, an important market barometer, is heading toward 2% and that could mean more volatility is ahead for the stock market. The last time the 10-year yield was at 2% was in 2019. The yield in the last few days has retraced to the 1.92% level it was at the end of 2019, prior to the pandemic. Indeed, the yield rose to 1.96% on Tuesday, a high not seen since November of that year. Yields, which move opposite price, have been rising on expectations the Federal Reserve will hike interest rates. Market strategists have been watching the rising 10-year yield, and expect there's a level where stocks will again react with volatility to its upward pressure. "I feel like that magic number is 2%," said technical strategist Katie Stockton, founder of Fairlead Strategies. The Fed is poised to raise the federal funds rate in March, and some market pros expect there could be six or more rate hikes this year. That concern has weighed on the stock market and rippled through the bond market, sending yields higher across the Treasury curve. Technology and growth stocks are the most negatively affected by higher rates, because investors have been willing to pay lofty valuations for their future profit growth. So when rates rise and money gets more expensive, the calculation changes and those stocks can look expensive. "If we look at the relative strength in the technology sector, it doesn't bode well for technology," said Stockton. "Using January as a foreshadowing, the dramatic underperformance by small- and mid-cap technology — you can't say it was a one-for-one relationship with yields, but certainly we saw some major acceleration higher in yields." Stockton is currently watching to see if the 10-year yield will again close above 1.79% on Friday for a second week in a row. That would be a confirmation of the trend. That level is the high from 2021 and also a key retracement threshold. "When it is confirmed, the targeted level is 2.13," she said. "For those who don't think rates are moving higher, they'll have to embrace it." Bigger sell-off ahead? CFRA's Sam Stovall said a bigger sell-off could be ahead for stocks, and rising rates could be the cause. The S & P 500 touched a low of 4,222 in January. "It's not like 2% is going to be an on switch. It's not an on-off switch," said Stovall, chief market strategist. But it could be psychological, and if investors fear rates will keep going higher, that will be a negative to see 2%, he said. "The higher it goes, the more pressure it places on stocks," said Stovall. Stockton, who watches charts, said the S & P 500 could retest the 4,200 area. The S & P 500 closed at 4,483 Monday. Yields have been going straight higher this year in anticipation of the Fed. They got an added boost after Friday's strong January jobs report and revisions, which showed job growth close to a pace of 500,000 a month in the November to January period. But the report also showed that wages rose sharply, up 0.7%, adding to concerns about inflation. On top of that, bond pros see more momentum for higher rates globally, due to the hawkish tones from the Fed and other major central banks. The Bank of England has raised rates, and the European Central Bank is now discussing increases. The bellwether German 10-year bund yield, long negative, has recently turned positive and was at 0.22% Monday. Yield knocking on 2% Michael Schumacher, Wells Fargo director of rates strategy, said upcoming auctions this week of 10-year and 30-year Treasurys could push rates higher, as could Thursday morning's consumer price index release. Dow Jones expects headline January CPI at 7.2%, the highest reading in 30 years. "It's knocking on the door of 2%," said Schumacher. "I think that's pretty attainable." The Treasury auctions $37 billion 10-year notes Wednesday afternoon and $23 billion 30-year bonds on Thursday. "I think the highfliers are vulnerable. It seems to me it's a pretty tough environment for risk assets when you have not just the Fed but a lot of other central banks tightening and talking about tightening," said Schumacher. Stovall said he, too, is watching the CPI for potential reaction. "We continue to see more evidence of elevated inflation. I think that could continue to pressure stocks," he said. Tech wreck The stock market's downturn is particularly painful since it has been led by technology, a favored sector. Of the big cap FAANG stocks, both Netflix and Meta Platforms have suffered big post-earnings declines. Amazon and Google parent Alphabet both gained after their earnings reports. Meta, the parent of Facebook, was down 5.1% Monday at $224.91, near its 52-week low. It has not made a comeback from the one-day 26% post-earnings drop last week. "You would think you'd see some buying in a setup like that. How often do you get major gaps down in Facebook? Nobody seems to be picking it up," said Stockton. Tech-like returns Stovall said investors have relied on tech for steady and outsized returns, but so far the sector is down 9% year to date. Last year, tech was the best performer and its annual outperformance is 300 basis points per year over the S & P 500. Since 1990, the S & P technology sector had a 13.9% compounded growth rate, including dividends. The S & P 500 growth rate was just 10.8%, he noted. But a portfolio of half consumer staples stocks and half technology over that period would have returned 13.4%, nearly as much as tech. "Through the power of correlation, or the simple matching of two sectors that proceed at dissimilar rates of pace, one could have enjoyed a return that rivaled that of tech but with 40% less risk," he noted. The portfolio could be created by using equal parts of the Consumer Staples Select Sector SPDR Fund ETF and the Technology Select Sector SPDR Fund ETF. "Because investors gravitate towards defensive sectors when things are challenged, they hold up better," he said. Also when looking at total returns, consumers staples tend to pay steady dividends The portfolio also outperformed the broader market in 85% of the past 26 years.

Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, January 25, 2022.

Brendan McDermid | Reuters

The 10-year Treasury yield, an important market barometer, is heading toward 2% and that could mean more volatility is ahead for the stock market.