Over the past week, long-duration Treasury rates moved up surprisingly quickly. The 10-year Treasury rate is now at 1.34%.
If we look at the yield curve, which means the 10-year Treasury rate minus the 3-month Treasury rate, we can see that it’s steepening, as it often does at this part of the economic cycle:
G Fund investors benefit from this move because they get paid higher interest rates with no volatility, whereas actual holders of 10-year Treasury notes faced some capital losses from this move unless they hold to maturity.
Meanwhile, the market is currently pricing in forward inflation that is notably higher than current rates (orange line below), suggesting that rates (purple line below) still have the potential for more upward moves unless the Federal Reserve takes more action to keep them suppressed:
Low Treasury rates have an inverse affect on equity valuations.
Years ago, Treasuries often yielded over 5%. So, if you were looking to buy a stock, you would demand a pretty high expected rate of return, maybe 10% or more, since you can get 5% risk-free.
However, with yields below 1% for most of the past year, and currently still below 2%, investors are more willing to pay high valuations (and thus accept lower forward returns) for equities, since they don’t have many other good places to put their money.
Professor Robert Shiller showed long ago that in most situations (with notable exceptions being World War II and the Dotcom Bubble), that equity valuations in the long run tend to be inverse to Treasury yields:
If we look at individual stocks, we see that a lot of this has showed up in growth/tech stocks. Apple, for example, has had good fundamental performance in recent years in terms of earnings (blue and orange lines below), but its stock price (black line below) has utterly soared, thanks to a very high valuation in this low interest rate environment:
As always, it’s a good time to review your portfolio to make sure your asset class allocations are appropriate for your situation. It can be a mistake to assume that recent performance is indicative of future performance, when in reality more often than not, things tend to go in cycles.
The TSP provides good diversification for domestic stocks, foreign stocks, and bonds. In other accounts, investors can also diversify into emerging markets, precious metals, digital assets, or commodities, as desired. Real estate, via a primary residence or with rental properties, is another asset to take into account when analyzing and diversifying your overall investment position.
Lyn Alden is a financial writer and an engineer, and holds a bachelor’s in engineering and a master’s in engineering management, with a focus on financial modeling and resource management. She specializes in analyzing and presenting financial data. Her investment work can be found on LynAlden.com.