Bonds have a reputation for being stodgy and boring; as such, they’re not normally on the tips of investors’ tongues when talking about markets. But when bonds are suddenly the talk of the town, it’s not usually a good sign for stocks.
It happens that now is one of those rare times when bonds are getting lots of attention, and not because bond prices are levitating. Instead, rising bond yields are the focus, with the benchmark 10-year Treasury Yield Index (TNX) recently hitting its highest level since April 2002, at just over 5.3%.
This level carries a deep psychological significance for investors since TNX experienced a sustained rise above that level that accompanied the dot-com bubble collapse and subsequent bear market. It’s a level that has served as a bearish catalyst—or at least a major headwind—for equities over much of the past quarter of a century.
What’s more, TNX briefly hitting 5.3% in mid-2007 arguably increased selling pressures and served as a catalyst, or at least an accelerant, for the credit crisis that followed. With this background in mind, it’s understandable that investors are concerned over the latest yield spike to the much-feared 5.3% level.
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As contrarians, however, this naturally begs the question: Are the fears over high bond yields overblown? After all, 10-year yields considerably above 5.3% commonly prevailed in decades prior to the 2000s—even as stock prices remained elevated. Therefore, a case could be made that investors’ fears over current bond yield levels are misplaced and based more on the arguably abnormally low bond yields of the last couple of decades, rather than on the historical norm.
The Contrarian Case That High Bond Yields Are Nothing to Fear
That’s precisely the argument that Wall Street economist Ed Yardeni has made in stating his case that current bond market worries are exaggerated, with bonds likely near a turning point. To underscore his case, he pointed out that this week’s edition of The Economist features the headline, “Will bonds blow up?” on the front cover. The so-called “front cover indicator” is well known to contrarian investors, who recognize that whenever an established market trend makes the cover of a mainstream magazine, it’s often a sign that the trend has reached its terminus.
Yardeni makes the case that this is likely true for the bond yield rally, with investors likely having “moved on,” in his words. He further writes: “We think the 10-year Treasury bond yield is back to normal this year, i.e., in the 4.00% to 5.00% range.”
He further argues that the popular “higher for longer” argument that interest rates are likely to remain elevated—which in turn suggests they’ll come back down—is erroneous. Instead, Yardeni maintains that “interest rates are likely to stay normal for longer.”
In other words, the exceptionally low interest rates that prevailed following the 2008 financial crisis and before the pandemic were the historical anomaly, in his view, and investors should therefore prepare for a sustained period of more historically normal yields. That means stronger demand for bonds at higher yields helping to keep the 10-year Treasury yield within his projected 4%–5% range.
My view largely aligns with Yardeni’s, though I see the potential for higher yields in the coming years as the secular inflation cycle continues to exert its influence. But from a near-term perspective, I think Yardeni is likely to be proven correct, with TNX pulling back from its multi-decade high over the next few months.
If that indeed proves to be the case, it should prove beneficial for equity prices. And I think that can be considered a contrarian signal for investors as we head further into the normally bullish Q4.
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