The flight to safety continues in the bond market, pushing the U.S. 10 Year Government Bond to 2017 levels. Normally a bond rally like the one we have seen leads to a sell off in equities. However, that is not what we have seen; in fact, the S&P 500 has increased 2.17% in the last week.
Does that mean stocks will not be hurt by the flight to safety? The Surevest Investment Committee researched past declines to provide guidance.
Over the last week, the 10 Year U.S. Treasury yield has declined a little more than -10.5%; that is a rapid decline in a short period of time. To provide some perspective, yield declines of that magnitude or greater has only happened less than 1% of the time since 1980.
The traditional investment framework is that lower yields is caused by people selling stocks and buying bonds, which acts as a headwind to equities in the short run. However, in the long run, lower yields in the U.S. 10 Year Bond makes equities more attractive. The U.S. 10 Year Bond is considered the risk-free rate in cash flow models and as this rate decreases, all else equal, the discount rate used in equity valuation lowers and actually makes stocks look more attractive.
The study we performed shows that in the past, after yields have dropped by more than -10% in a five-day period, stocks do better in the short term. One month after such an occurrence, the average return on the S&P 500 has been 3%, and a year later, it has increased on average by 22%. Lower yields not only put more money back into the economy through lower borrowing costs, they also make the yield and growth of equites, when compared to bonds, much more appealing.
The data supports that even though there is a lot of geopolitical risk and increased volatility, investors that have a well thought out investment and financial plan should not panic. Investors that focus on what they can control, cash flows, and stay disciplined through the volatility, are compensated generously on average.