How Much Should the 10 Year Treasury Matter to Stock Investors?

Treasury Bills

The dropping yield of 10-year treasury bills have really been in the news lately, because of an inversion. How much should we even be concerned about 10-year treasuries?

There are a number of reasons why the price and yield of treasuries such as the 10-year differ, and it’s not all just about people predicting rough times ahead. It is important to understand how this all plays out if we have any plans of changing our stock holding strategies based upon how the treasury market is doing.

Treasuries, and all bonds in fact, have their prices determined by the market forces of supply and demand for these securities. While we might think that the prices go down when more people are selling than buying, it’s not that for sure, as there are always an identical number of buyers and sellers as every transaction has both.

This is still a numbers game, but it comes down to how much these traders will pay to buy something and how much they will take to sell it. Both buyers and sellers maintain standing orders which are subject to filling once they find a trading partner.

If the inventory offered at a certain price is bought, and people want to buy more right now, they will then move up to the next level of orders at a higher price. These orders also move around and will be raised if the trend is toward higher prices, to look to capitalize more on these moves.

The same thing happens in reverse when prices go down. When we look to the direction of the market, we then can learn whether there is more pressure to drive prices up rather than down, and if one side is winning out more, like with prices rising with 10-year treasuries, we know that it is under accumulation.

When bond prices go up, their yields go down, and the reason is that these securities provide a set rate of return over time, and if you pay more for that income stream your return on investment, or yield, will be lower.

Why Should Stock Investors Care About 10-Year Yields?

We might think that all of this should matter, maybe even a lot, to people who own stocks, but all we have here is people buying more or less bonds. This in itself actually has nothing to do with stocks, because it is a completely distinct asset and market, other than some of this money could have been invested in stocks instead.

Since it wasn’t though, that’s a completely moot point. It is like saying that a stock rally could be bigger if these people invested in stocks more, but they didn’t. If they got a lot of the extra money that has been invested in bonds from cashing out stock positions, then we may see more of a correlation here, although we could get a complete one by just looking at stock prices.

Some think that a declining 10-year means that the outlook for this time period is poorer, and then stocks should just grab their hand and walk down this path as well, but once again, the best way to see what path stocks are on is to look at what path stocks are on and not bonds.

It’s not that we cannot learn from watching bond prices. For example, we know now that the bond market is not discounting the future with this instrument as much as it did last fall. The first thing that should come to mind is that this is really based upon inflation, which is what bonds are centered upon.

Discounting the future can be subjective, but with bonds, it’s all objective. Bond markets don’t care at all about things like how stocks are doing or even how business is doing, and while they do care about the economy, the only thing they care about it is how interest rates will move.

The bond market isn’t rooting one way or the other either, it is inflation neutral, and will just price in whatever amount of inflation is expected. It’s pricing in less with the 10 year and other treasuries, which isn’t necessarily a bad thing for stocks and is generally a good thing as long as we keep this positive.

10-Year Yields Aren’t Really Correlated with Stocks

If we’re thinking that a 10 year yield this low, at 2.432%, is predicting the sort of low levels, we only need to look at other times when yields were as low or lower and see what happened.

We were all the way down to 1.38 back in July 2016. The S&P has increased by a third since then. This really all depends on the direction of the market pretty independently of the movements of the 10-year yield, which really dances to its own beat and can move up and down a lot during a single stock market trend.

We also need to ask ourselves what actionable time frame that a 10-year yield is suggesting. All we know is people see less inflation than they did over the next 10 years, which is a long way away from any reason to buy or sell stocks. The interim period, from now to approaching 10 years, isn’t even that well defined at all, other than to suggest that during this latter period we may expect inflation to be on the lower side, and this is at best an average without specifying the variations along the way.

We also need to ask how reliable this information is. We really don’t know that much at all about what will be going on over the next 10 years. We need to guess because people trade these instruments, but the best we can do is make pretty wide guesses.

If we’re trading stocks based upon what the bond market is guessing inflation will be in the next 10 years, we need to ask ourselves why we would ever consider such a thing. On the other hand, if this becomes trendy, bond yields can indeed affect stock prices, if people start selling more, just like such things as Santa Claus and the moon phase can affect trading.

We might then say that this isn’t at all about 10-year yields, it’s about the 3 month and 10-year yield inversion, but in this case it’s really not. 10-year yields falling is what is going on here and the only thing going on in fact, and their dropping this low once again means that they expect inflation will be low in 10 years.

If we started to see the 3-month drop like this, then we might want to worry, because the time frame is right in front of our faces. A serious enough drop here may indeed portend a recession, which stocks really hate, since predictions over such a short time frame is so much more reliable than the far away ones can possibly be.

Looking at the various treasury yields can tell a story at least, comparing different time frames and seeing where the bond market sees inflation at various points in the future. If we’re in stocks, dramatic changes in short-term yields may be quite noteworthy, but anything involving 10 years away will not be at all.

If too many people are howling at the moon over what is essentially just a bull run for the 10-year, and then selling their stocks enough to drive the market down significantly, we do need to pay attention to this of course. Short of that, we really don’t want to be doing too much howling ourselves over what is essentially a pretty irrelevant indicator for the stock market.

Andrew Liu

Editor, MarketReview.com

Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.

Contact Andrew: [email protected]

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