Market Overview

Stocks Face Further Losses As Rates Surge

  • Yields have risen sharply since the middle of August
  • Stock prices have fallen but not fast enough to account for the drop in bonds
  • This would indicate that stocks may still have further to fall

Yields have rocketed higher, and stocks have failed to keep pace with the surge. So despite the recent plunge in equity prices, indexes like the S&P 500 are more expensive today relative to bonds than before stock prices fell. It doesn’t make one feel good now, does it?

Looking at the spread between the S&P 500’s earnings yield over the trailing twelve months and the current 10-year Treasury rate shows that the spread has contracted. That spread is now around 1.84% and the significantly lower end of its historical range of the past ten years.

S&P/10-Year Yield Spread

Failing To Keep Pace

Even more shocking is that the index has fallen by more than 8% since Aug. 16, yet the spread between the earnings yield and the 10-year is lower. In August, that spread was at 1.93%, which tells us that stocks today are more overvalued relative to bonds due to the speed at which yields have increased.

On Aug.16, the 10-year rate was around 2.75%; now, it is trading around 3.3%, a massive move in a brief period. This would tell us that despite the sharp decline in the equity market, stocks haven’t fully priced in higher yields and that stocks still need to fall further to account for the move higher in rates.

S&P/10-Year Yield Spread

Another 9%?

How much lower should stocks fall, of course, becomes the next question. For that, we can turn and look at where the spreads were in June and July, and at that time, they were between 2.2% and 2.6%, and if we take the middle of 2.4%, stocks would need to reflect an earnings yield that is about 50 bps higher than today, assuming the 10-year rate is unchanged.

That would push the earnings yield on the S&P 500 from around 5.15% today to about 5.65%, pushing the PE ratio from 19.4 to 17.7. Assuming earnings over the last twelve months of $204.91 would knock the value of the S&P 500 to 3,626 from its current 3,975, or a drop of about 9%.

S&P Earnings Yield


The stocks that could get hurt the most in such a decline would be those that have seen their valuations rise or fall due to rates thus far. That would be stocks in the growth sector and many technology stocks or stocks that continue to carry high valuations in general.

It seems easy to see that despite stocks falling since Jay Powell’s Jackson Hole speech, the Fed isn’t going to back off tightening monetary policy anytime soon. That should make stocks worth less versus bonds and not worth more. Given the enormous move in yields, one would expect stocks to reprice along with bonds, especially since the Fed has proven it will be more aggressive than the stock market had anticipated.



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